Lithia Motors, Inc. (NYSE:LAD) Q1 2024 Earnings Call Transcript

Lithia Motors, Inc. (NYSE:LAD) Q1 2024 Earnings Call Transcript April 24, 2024

Lithia Motors, Inc.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to Lithia Motors First Quarter 2024 Earnings Conference Call. At this time, all participants are on a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Amit Marwaha. Thank you. You may begin.

Amit Marwaha: Thanks for joining us for our first quarter earnings call. With me today are Bryan DeBoer, President and CEO; Chris Holzshu, Executive Vice President and COO; Tina Miller, Senior Vice President and CFO; Chuck Lietz, Senior Vice President of Driveway Finance; and finally, Adam Chamberlain, Chief Customer Officer. This discussion may include statements about future events, financial projections and expectations about the company’s products, markets and growth. Such statements are forward-looking and subject to risks and uncertainties that could cause actual results to materially differ from the statements made. We disclose those risks and uncertainties we deem to be material in our filings with the Securities and Exchange Commission.

We urge you to carefully consider these disclosures and not to place undue reliance on forward-looking statements. We undertake no duty to update any forward-looking statements, which are made as of the date of this release. Our results discussed today include references to non-GAAP financial measures. Please refer to the text of today’s press release for a reconciliation of comparable GAAP measures. We have also posted an updated investor presentation on our website, investors.lithiadriveway.com, highlighting our first quarter results. With that, I would like to turn the call over to Bryan DeBoer, President and CEO.

Bryan DeBoer: Thanks, Amit. Good morning, and welcome to our first quarter earnings call. Our Lithia & Driveway teams remain focused on driving results and continuing on our journey to building a unique and highly profitable customer ecosystem. For LAD, the windfall of elevated GPUs for the past four years provided the extra capital that allowed us to grow revenue and earnings by nearly 3 times and build, acquire and fund all our crucial differentiating strategic adjacencies, Driveway, GreenCars, DFC and Pendragon Vehicle Management, or PVM. These important design and scale advantages have built a definitive pathway to a higher margin and lower cost business. While the extra capital helped us build out our advantages, we have been clear that elevated GPUs would return to some level of normality.

We remain diligent and nimble throughout this normalization process, still seeing that combined vehicle GPUs, because of geographic and manufacturer mix improvements, along with our unrealized performance potential, will normalize between $4,300 and $4,500 per unit. As strange as it may seem, my team and I welcome normalization and getting back to working for our profits through providing rich and irreplaceable experiences one customer at a time. Our current global footprint, core competency of acquisitions, growing high-margin adjacencies and experienced operationally focused leadership at all levels of the organization combined to form our strategy. We are positioned to deliver strong growth through reinventing our industry’s customer experiences and achieving a LAD profit equation of $2 of EPS for every $1 billion of revenue.

Now on to some highlights for the first quarter. Lithia & Driveway grew revenues to $8.6 billion, up 23% from Q1 of last year, helping outrun some of the declines in GPUs. Vehicle operations experienced weaker performance in January and February with declining new vehicle GPUs and used vehicle GPUs at below normalized levels. March, however, did improve, exceeding our internal expectations with good momentum in unit volumes and stronger used vehicle GPUs. Our investments in adjacencies are maturing as well as the path to profitability. Financing operations produced strong results with a loss of less than $2 million in the quarter compared to $21 million loss last year and over 90% improvement. Driveway and GreenCars burn rates have also been cut in half compared to a year ago as we continue to refine our customer e-commerce strategies, improve Driveway care center and advertising effectiveness, while continuing to convert new customers.

As a result and driven by market conditions, we generated adjusted diluted earnings per share of $6.11, a decrease of 28% from Q1 of last year. We continue to proactively manage our business with decisive actions aligned with local market and manufacture partner trends, leaning into what we know best: execution. Let’s move on to same-store sales results and vehicle operations. Total same-store sales revenues were down 2%, driven by ASP declines and gross profits declined 7%. Despite continued affordability issues from ASPs and higher interest rates, we continue to see resilience in the automotive consumer, though a bit less willing to pay a premium. MUVs across all our digital channels increased 9% quarter-over-quarter, reaching $12.3 million per month.

Digital transactions including Driveway grew to over 40,000 in the first quarter, up 32% compared to last year. GreenCars, the leading sustainable vehicle education channel, continues to grow as the lead generation channel and contributed over 730,000 MUVs, up 71% over last year, doing so with very little expense. Our teams have made great strides towards profitability in Driveway and GreenCars, and I want to commend Adam Chamberlain and Diana Deprez and their teams on the progress we have made in such a short time and their vision to achieve a profitable e-commerce channel someday soon. New vehicle revenues were up 2%, while gross profit declined 27% compared to the prior year. Unit volumes increased nearly 4% with ASPs declining 1%. New vehicle GPUs, including F&I, were $5,771 per unit, down $512 compared to Q4 and down $1,640 or 22% year-over-year.

With the return of inventory supply, we have seen an accelerated pace of GPU normalization to nearly $150 per month. New vehicle inventory day supply was 60 days compared to 65 days at the end of Q4 and 51 days at the end of the first quarter 2023. Moving on to used vehicles. Revenue was down 5% with units down only 2% and ASPs declining 3%. Used vehicle pricing is moderating in line with the recovering supply of new vehicles, and we continue to see the impact of lost production from 2020 to 2023, moving through our certified and late-model vehicles. Used vehicle GPUs including F&I were $3,901, up $150 per unit compared to Q4 and down $153 per unit compared to last year. As you may recall, Q1 and Q4 are traditionally the weakest quarters, and we are seeing more normalized seasonality trends in used cars.

As new vehicle retailers, we are top of the procurement funnel, giving us significantly more access to inventory than used owned dealers. This provides us a significant advantage as we continue to source over 70% of our used inventory directly from consumers. Our strategy of selling one to 20 year-old scarce vehicles also provides a vast opportunity to our new stores. To put it in perspective, nearly two-third of our stores have been recently acquired, and this continues to be a massive opportunity for us to gain market share and increase profitability. Our used vehicle inventory day supply was 58 days compared to 64 days last year and 53 days in the previous year. F&I per unit was $2,080 in the quarter, declining $123 compared to last year.

We continue to see consumers working to balance affordability due to higher ASPs, increasing negative equity and high interest rates. This has created some affordability tension on monthly payments impacting F&I product penetration rates positively on financing, up 150 basis points, and negatively on service contract penetration rates, which declined 270 basis points as compared to last year. Now on to aftersales. For the quarter, revenues increased 3% and gross profit increased 7%. Customer pay revenue, which accounts for 56% of the aftersales business, was up nearly 3%. While warranty sales, which makes up 23% of the business, increased by 10%. Aftersales continues its steady performance of growth despite our primary driver of one to four year-old vehicles in the car park being the smallest in over a decade.

This speaks volumes to strong upside created from the complexity of a growing number of different propulsion systems, resulting in longer warranty periods and a stickier customer attachment to new vehicle retailers. Moving on to acquisitions and our long-term strategy. We completed the Pendragon acquisition at the end of January, establishing our partnership with Pinewood Technologies, adding a profitable fleet management business and rounding out our footprint in the U.K. by adding a net 140 locations. In addition to Pendragon, we expanded our U.S. footprint in our least dense North Central region with the addition of the Carousel Group. To date, in 2024, we have acquired $5.4 billion in annualized revenues, and I would like to personally welcome all our new associates to the Lithia & Driveway family.

Acquisitions are our core competency at LAD, and we remain disciplined as we look for accretive opportunities that can improve our network. As a reminder, we target after-tax return of 15% or greater and acquire from 15% to 30% of revenue or 3 times to 6 times normalized EBITDA. Life to date, our acquisitions have yielded over a 95% success rate and after-tax returns of over 25%, demonstrating that LAD is not your typical high-risk roll-up strategy. Our scale allows us to find our growth through acquisitions and adjacencies through free cash flows and reasonably leveraging our balance sheet. With elevated acquisition pricing, current stock valuation and placing M&A and share buybacks at parity, we have adjusted our capital allocations to target 50% to 60% towards acquisitions and 15% to 25% towards shareholder return.

We continue to monitor valuations on both acquisitions and share repurchases, being patient for strong assets priced within our acquisition hurdle rates. We still expect pricing to take some time to rationalize and reiterate our expectations that estimated future annual acquired revenues will be in the range of $2 billion to $4 billion a year. The foundation of the LAD strategy is our vast store network made up of the industry’s most talented people, highest demand inventory and dense expansive physical network. We have built and will continue to build the most extensive network in North America and the U.K. and added important foundational adjacencies and strategic partnerships to modernize the customer experience and diversify our profitability.

Operating in one of the largest retail addressable markets in the world, we have built and solidified our ability to continuously grow in all aspects of our business. Expanding consumer solutions that are simple, convenient and transparent is the heart of our strategy, allowing us to capture more of the consumer wallet share and create a sticky and natural retention of consumers within our ecosystem. Magnetic brands like Driveway and GreenCars provide a pathway to 50 times more customers than our core business offer. Solutions such as Pinewood Technology, bring the ability to increase associate productivity and substantially improve our current customer experience, stitching together our robust ecosystem and placing it at our customers’ fingertips.

Combined with our mission, growth powered by people, financial discipline and regenerative free cash flows, we are able to respond quickly to local market dynamics while increasing the touch points throughout the customer life cycle through our adjacencies and equipping our stores with the tools necessary to improve market share, loyalty and ultimately profitability. Weaving these elements together and assuming a normalized SAAR and GPU environment, we continue to see a clear pathway to $1 billion in revenue, ultimately generating $2 in EPS. Key factors underlying our future steady state and now totally within our control are as follows: first, continuing to improve our operational performance by realizing the considerable revenue and profit potential within our existing stores by increasing our share of wallet through greater customer life cycle interaction, leveraging our cost structure, personnel productivity gains and growing each store’s new and used and aftersales market share.

In the long term, we look to achieve an SG&A as a percentage of gross profit with adjacencies in the mid-50% range in a normalized GPU environment. Tina will be providing more color on the impact of our U.K. footprint on SG&A in a few moments. Second, continue focusing on acquiring larger automotive retail stores and the higher profitability regions of the Southeast, South Central and North Central United States. Combined with further growth in digital channels, we expect to reach a blended U.S. market share of 5%. Today, we are at a combined new and used vehicle market share of 1.2%. Third, financing up to 20% of our units with DFC and maturing beyond the headwinds associated with CECL reserves. As a reminder this is our first adjacency and it remains on track to achieve consistent profitability during the latter half of 2024.

Next, maturing contributions from our horizontals, including fleet management, DMS software, charging infrastructure and captive insurance. Fifth, through size and scale, we will continue to drive down vendor pricing with solutions like Pinewood Technologies, which improved corporate efficiencies to save costs and lower borrowing costs as we pathway towards an investment-grade credit rating. And finally, ongoing return of capital to shareholders through dividends and opportunistic share buybacks. Please refer to Slide 14 of the last investor presentation for further details and reconciliations. As we approach the middle of the decade, we are well positioned to maximize our unique and powerful mobility ecosystem that is ready to deliver more frequent and richer customer experiences throughout the ownership life cycle at global scale.

Our strategy, combined with our experienced and focused team, will continue to expand market share, leverage our size and scale and grow our complementary adjacencies to produce an ultimate long-term EPS to revenue ratio of over 2:1. All elements of our original design are now securely in place, and we look forward to focusing all of our attentions on execution to establish new levels of performance for our industry. With that, I’d like to turn the call over to Tina.

Tina Miller: Thanks, Bryan, and thank you to everyone joining us today. Our financing operations segment, primarily driven by DFC, continues to grow, and we see clear line of sight on how this adjacency is now providing incremental profitability and diversifying our business model as it matures. As a reminder, a loan originated by DFC is expected to contribute up to 3 times more profitability compared to traditional indirect lending. The financing operations segment moved toward profitability with a first quarter operating loss of $2 million, down from $21 million last year in Q1 and a portfolio balance growing to over $3.5 billion. Within the United States, DFC’s penetration rate was 11.7%, up from 10% last quarter. We continue to strategically balance yields growth and risk through our underwriting and focus on high credit quality loans at market interest rates.

Origination volume was $493 million during the quarter, a 15% increase compared to Q4 2023. The weighted average APR on loans originated was 10.2%, essentially flat compared to the prior quarter and up 124 basis points from a year ago while originating at a consistent credit quality. Loans originated in the quarter had a rated average FICO score of 735 and a front-end LTV of 95%, consistent with the prior quarter. As a 100% captive auto loan portfolio, DFC can have first and last look on deals that fit our credit risk appetite, providing ample opportunity to grow while maintaining our underwriting standards, particularly in the used vehicle market. Net provision expense increased slightly from the prior quarter to $25 million, driven by the growing portfolio.

The allowance for loan losses as a percentage of loan receivables stayed flat at 3.2%. 30-day delinquency rates decreased 80 basis points from the prior quarter to 3.8%, consistent with seasonal expectations and were flat year-over-year, reflecting the maturing portfolio and continued execution from our loan servicing team. Our financing operations business continues to perform as expected, and we reiterate our expectation to break even in 2024. We remain confident in the financing operations ability to deliver long-term earnings growth to LAD and achieving our end-state financial goals with a fully scaled and seasoned portfolio. Simply put, the best is yet to come as this first adjacency can take us a long way towards our 2:1 EPS to revenue target.

Moving on to SG&A. Adjusted SG&A as a percentage of gross profit was 69.4% during the quarter, mainly reflecting the higher expense profile of our U.K. business. On a same-store basis, which excludes the impact of the Pendragon stores and is more representative of our historical performance, our adjusted SG&A as a percentage of gross profit was 66.9%, a 180 basis point increase from the fourth quarter mainly driven by declining new vehicle margins and below normalized level used vehicle margins early in the quarter. With the completion of the Pendragon transaction, our U.K. business represents 18% of our revenue mix and 13% of our gross profit mix in the quarter. We thought it would be helpful to provide some early insights on the financial profile of our U.K. business as it becomes a more meaningful part of our consolidated results going forward.

Total vehicle gross profit per unit in the U.K. was $2,600 in the quarter, 45% lower than our North American vehicle operations. One of the main contributors of this difference is regulations around F&I in the U.K., resulting in a lower F&I per unit. Gross profit mix from aftersales is similar in the U.K. at just under 40%. Our U.K. footprint is comprised of smaller stores compared to our average North American location with a revenue average of less than $50 million per store. While knowing this leading into the investments, the smaller store size with SG&A being more fixed in nature, resulted in SG&A as a percentage of gross profit at 85% during the quarter for the U.K. As a result, we see our consolidated SG&A as a percentage of gross profit increasing to the mid- to high 60% range in the near term with our long-term targets moving to be in the mid-50% range as GPUs normalize, and we continue to optimize our business and mature our adjacencies.

We see opportunity to increase profitability over time in the U.K. as we fully integrate the teams into the Lithia & Driveway culture, migrate our stores into a single platform on the Pinewood DMS system and drive higher levels of performance. As previously discussed, we are actively working on optimizing the U.K. network. Moving on to our balance sheet and cash flow performance. During the quarter, we completed an amendment to our main credit facility used to fund our vehicle floor plan and working capital, increasing the capacity from $4.6 billion to $6 billion and extending the maturity to 2029. This solidifies our capital structure to take us beyond $50 billion in revenue. I want to take a moment and thank all of our banking partners for their support and continued confidence in our business.

We reported adjusted EBITDA of $362 million in the first quarter, driven by continued strength in new vehicle sales and aftersales, offset by lower new vehicle GPUs with returning supply and higher floor plan interest expense. Unique to our industry is the financing of vehicle inventory with floor plan debt. This finance is integral to our operations and collateralized by these assets. The industry treats the associated interest as an operating expense and EBITDA and excludes the debt from the balance sheet leverage calculation. Similarly, as we have ABS warehouse lines and ABS issuances to capitalize DFC, we exclude those from our leverage calculations. Adjusting for these items, we ended the quarter with net leverage of approximately 2.25 times, comfortably below our target of 3x and our banking covenant requirement of 5.7 times.

We continue to maintain our financial discipline even with planned growth and target leverage below 3 times. During the quarter, we generated free cash flows of $218 million. We define free cash flows as EBITDA adding back stock-based compensation less the following items paid in cash, interest, income taxes, CapEx and dividends. Free cash flows were impacted by the declining EBITDA and an increase in capital expenditures compared to prior year, mainly related to construction at recently acquired locations to meet manufacturer requirements. The benefits of our capital allocation strategy is the regenerative cash flows generated from our business, allowing us to preserve the quality of our balance sheet while supporting our growth initiatives and navigating various cross currents in today’s environment.

Being responsive to valuation trends, we evaluate M&A opportunities in the near term on parity with being opportunistic in our share repurchases. We have adjusted our capital allocation strategy to target 50% to 60% toward acquisitions, 25% toward internal investments which includes capital expenditures and the balance of 15% to 25% towards shareholder return. Since the end of the quarter and as of the end of last week, we have repurchased approximately 58,000 shares at a weighted average price of $264. Approximately $452 million remains available under our share repurchase authorization. Our vision and ability to deliver on synergies through acquisitive growth remains unchanged, and our strategy is flexible with the consistent cash flow generation of our vehicle operations business, coupled with our ability to deliver on accretive acquisitions.

The team has the necessary infrastructure and tools to drive revenues and margins toward our long-term target of achieving $2 in EPS per $1 billion in revenues and our focused on execution. Our culture and business is designed to grow and deliver consistent strong performance, and our diverse and talented members of our team give us the necessary foundation to achieve our plan and to continue driving value for our shareholders. This concludes our prepared remarks. With that, I’ll turn the call over to the audience for questions. Operator?

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Q&A Session

Operator: Thank you. At this time we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Ryan Sigdahl with Craig Hallum. Please proceed with your question.

Ryan Sigdahl: Hi, good morning, Bryan, Tina. I want to start on new GPUs. They declined a little bit more sequentially, I think, than you guys and us expected. But curious what you’ve seen in April. And then any expectation kind of for the next several quarters through the rest of this year?

Bryan DeBoer: Sure, Ryan. Thanks for joining us today. We did see a slight acceleration to around $150 a unit in the quarter. We also — imports were up, which — up about 9% in revenues and units which carried some of that which is typically a little bit lower cost cars, doesn’t have quite as many trucks. So that could have been some of the influence there. The other thing I would say is we’re still at about $1,000 higher, including F&I, of where we believe normalization will finally fall into line, okay? And there’s still some work to go. We also have a small amount of regional differences. But all in all, I mean, that’s where it started with really, the top level where GPUs fell a little bit more than what we really expected at the $100 a month.

Ryan Sigdahl: Good. And if I could just ask one longer-term question. If I’m looking at Slide 14, kind of the bridge to that $100 billion of sales, $1.75, $2 of EPS. If I look back to the previous expectations, operating margins were expected to be 7% plus, now 5% plus. I guess, what’s the offset there, assuming lower operating margin but similar EPS flow through?

Bryan DeBoer: Sure. About half of that is the bringing on of Pendragon. So the dilution of lower margins from the United Kingdom affected to some degree. And I think the rest is more conservative that we — that other things that are below operating margins such as interest costs or possibly buybacks can influence things a little bit more as well. Thanks, Ryan.

Ryan Sigdahl: Very good. Thanks, Bryan. Good luck, guys.

Operator: Our next question comes from Bret Jordan with Jefferies. Please proceed with your question.

Bret Jordan: Hi, good morning, guys. Could you talk a little bit more about F&I? I mean, obviously, it’s hard to attach extended warranties to customers that can barely afford the rate side of the equation. But do you see much downside in F&I? Or are we sort of stable at the run rate in the first quarter?

Bryan DeBoer: We were down $124 a unit. New was down a little bit more at $180. So we’re seeing a lot better incentives when it comes to fleet and finance, which takes away some of our profitability because of flat fees. So that has a little bit to do with it. And then obviously, as we continue to penetrate with DFC, that influences a little bit as well. We were up to what about 11.5% penetration rate, which is quite nice. But it does influence — that’s in finance, obviously. Whereas when we don’t get the reserve from our third-party lenders, it does lower GPUs a little bit. We believe a normalized state, Bret, is probably in the $1,900 range, okay, because there is some impact that will come from ASPs, which just is a given throughput of a lower cost amount means a lower finance income. But outside of that, I think we’re seeing a nice trend there towards that normalized state.

Bret Jordan: Okay. And then you talked about the trend in the quarter of January, February seeing some below normalized levels and March improving. Could you talk about the U.K. trend in the quarter?

Bryan DeBoer: Chris, do you want to talk about the U.K.?

Chris Holzshu: Yes, you bet. Good morning, Bret. So U.K. kind of has an anomaly every quarter, and the anomaly in the first quarter tends to be a massive March with a lot of deliveries with the plate changeover that you have. So you have a kind of a very modest January, a very modest February and then a monster March, and that came to fruition like we expected. The focus, though, longer term, obviously is continue to figure out how to get kind of more consistency in the business in each of the quarters and try to match a little bit more relatively to some of the performance that we see in the U.S. outside of the F&I performance, which is much more regulated in the U.K. than it is in the U.S.

Bret Jordan: Okay. And Bryan, a follow-up question, is leasing going to be a headwind to F&I because there’s just less attachment as leasing comes back? Or is that not material for you?

Bryan DeBoer: It is, and that was one of the things that I had mentioned, that with subvented leasing, and that’s where a lot of the incentive dollars are still going, we’re basically at a normalized state of incentive dollars in leasing, which obviously is in flat fees. So it does impact our F&I. I think it’s important to also point out that finance incentives are still off somewhat. So they’re about half of where they normally are, which means that those finance customers still aren’t getting quite the benefits of manufacturer incentives of lower, more affordable pricing. And then most importantly, for cash buyers, it’s still down like 80%, meaning that the incentives that are coming on the hood for cash directly to the consumer is still down considerably. And I think that obviously can be good tailwinds in the future as that begins to come back. Thanks, Bret.

Operator: Our next question is from John Murphy with Bank of America. Please proceed with your question.

John Murphy: Good morning, everybody. I just wanted to follow up on the comment you made, Tina, about sort of some pressure on the used business early in the quarter. And it just seems like there’s pressure on used vehicle pricing which has been reasonably as expected, but it also seems like there’s a bit of volatility in that business. I was just wondering if you could kind of expand on that. And if there’s anything that is unusual in the first quarter that might normalize going forward? And it just sounds like things are a little bit more volatile there than usual.