Penske Automotive Group, Inc. (NYSE:PAG) Q3 2023 Earnings Call Transcript

Penske Automotive Group, Inc. (NYSE:PAG) Q3 2023 Earnings Call Transcript October 25, 2023

Penske Automotive Group, Inc. misses on earnings expectations. Reported EPS is $3.92 EPS, expectations were $4.04.

Operator: Ladies and gentlemen, good afternoon. Welcome to the Penske Automotive Third Quarter 2023 Earnings Conference Call. Today’s call is being recorded and will be available for replay approximately 1 hour after completion through November 2, 2023, on the company’s website under the Investors tab at www.penskeautomotive.com. [Operator Instructions] I’d now like to introduce Anthony Pordon, the company’s Executive Vice President of Investor Relations and Corporate Development. Sir, please go ahead.

Anthony Pordon: Thank you, Leah. Good afternoon, everyone, and thank you for joining us today. A press release detailing Penske Automotive Group’s third quarter 2023 financial results was issued this morning and is posted on our website, along with the presentation designed to assist you in understanding the company’s results. As always, I am available by e-mail or phone for any follow-up questions you may have. Joining me for today’s call is Roger Penske, our Chair and CEO; Shelley Hulgrave, EVP and Chief Financial Officer; Rich Shearing of North American Interoperations; Randall Seymore, International Operations; and Tony Facione, our Vice President and Corporate Controller. Our discussion today may include forward-looking statements about our operations, earnings potential, outlook, future events, growth plans, liquidity and assessment of business conditions.

A tractor-trailer speeding along a modern highway, showing the power of the transportation solutions.

We may also discuss certain non-GAAP financial measures, such as earnings before interest, taxes, depreciation and amortization or EBITDA and our leverage ratio. We have prominently presented the comparable GAAP measures and have reconciled the non-GAAP measures in this morning’s press release and investor presentation, which are available on our website to the most directly comparable GAAP measures. Our future results may vary from our expectation because of risks and uncertainties outlined in today’s press release under Forward-Looking Statements. I’d also direct you to our SEC filings, including our Form 10-K and previously filed Form 10-Qs for additional discussion and factors that could cause future results to differ materially from expectations.

At this time, I will now turn the call over to Roger.

Roger Penske: Yeah. Thank you, Tony. Good afternoon, everyone, and thanks for joining us today. Our diversified business really produced another solid quarter, driven by strong performance from our North American Automotive and Commercial Truck Operations. The strong performance in North America was partially offset by lower earnings from our U.K. Automotive Operations, higher interest expense and lower equity earnings from our investment in Penske Transportation Solutions. As previous announced, third quarter results include approximately $6.2 million of costs related to the loss of inventory, property damage and business disruption from a hailstorm in Austin, Texas. It impacted our Texas — Toyota, Honda and Hyundai dealership, 750 vehicles worth $27 million in inventory.

During the third quarter, total units delivered increased 12% to 122,000, which includes 8,695 agency units. Good news is revenue increased 8% to $7.4 billion and our same-store retail revenue automotive increased 9%, including a 9% increase in service and parts. Same-store retail automotive variable gross profit per unit declined $466 sequentially from the second quarter of 2023 to $5,180. Same-store retail commercial truck gross profit increased 6%. Our net income was $263 million and earnings per share was $3.92. Last week, we increased the dividend by $0.07 per share or $0.10 per share to $0.79 per share. Let me now turn to our auto operations. Demand for new vehicles remains solid and availability, I would say, is improving. We continue to take forward orders.

Our U.S. presold inventory remains approximately 40% to 50%. In the U.K., our forward order book is 24,300 units and gross is only down 2%, representing about $98 million. Automotive operations in the U.K. during the third quarter were impacted by supply challenges, stop sales and a challenging used vehicle market, and of course, March is a registration month, so it’s awful key for us from the standpoint of our operation and profitability. Orders for 493 new vehicles were unable to be delivered in September. In addition, same-store used vehicle gross profit declined 30% as pricing challenges impacted the used market. Let’s look at our retail automotive business on a same-store basis for Q3. Total units delivered increased 10%, service and parts revenue increased 9% and gross profit, by the way, was up 10%.

Service and Parts revenue growth has been driven by an increase of 10% in customer pay, 7% in warranty and 14% in collision repair. Our variable gross profit remains strong and the higher than historical levels, obviously, for example, variable gross per unit of $5,180 is $2,000 per unit higher than it was in Q3 2019. Let me now talk a little bit about Penske Transportation Solutions. PAG owns 28.9% of PTS, which provides us with equity income, cash distributions and cash tax savings. PTS currently manages the fleet of over 442,000 trucks, tractors and trailers. In the third quarter, operating revenue increased 4% to $2.8 billion. Full service contract revenue increased 13%. Our logistics revenue increased 2%, while rental declined 9%. PTS generated $291 million of net income.

Our share of PTS earnings was $84 million, which declined by $51 million compared to Q3 last year. However, the good news is our share of PTS earnings increased $11 million sequentially when compared to Q2 of 2023. The decline in PTS earnings over the prior year period was mainly impacted, let me look at four items particularly, supply constraints and lease extensions increased the number of older units in operation and drove higher maintenance costs of $40 million in Q3. We also granted 18,000 lease extensions so far this year and 37,000 if you look over the last 21 months. Interest expense increased $64 million due to higher average outstanding debt obviously and the growth of our fleet, combined with $1.5 billion in re-financings and overall higher interest costs, a lower gain on sale of $61 million when compared to the record performance in 2022 as used truck values declined from historically high levels in the past.

Commercial rental utilization was 80%, compared to 84% in the third quarter. Our full-service long-term contract business remains very strong, increasing 13% in Q3. We believe the supply of new trucks is stabilizing and will provide PTS with an opportunity to replace the older vehicles in the fleet in the near future and this obviously will drive lower maintenance expense. Also, we believe freight rates will begin improving in the near future, which has historically helped our remarketing profitability. Let me now turn the call over to Rich Shearing to discuss our commercial retail operation trucks.

Rich Shearing: Thank you, Roger. Our Premier Truck Dealership business represents 44 locations in North America and is an important part of our diversification. Earlier this year, we expanded into Greater Winnipeg, Manitoba market area, acquiring five new locations and $180 million in estimated annualized revenue. Including the acquisition, our operations in Canada are approaching $1 billion in annualized revenue. These new dealerships have been fully integrated into our existing operations in Canada and are performing to expectation adding an important new market and significantly expanding our operations in Canada. We remain one of the largest Commercial Truck retailers for Daimler Trucks North America. New Commercial Truck demand remains solid and continues to be driven by replacement demand.

Our Class 8 allocation for 2023 remains sold out. Through September 30th, North American Class 8 retail truck sales were up 13% to 248,000 units. The current industry Class 8 backlog is 161,000 units, representing approximately six months of sales. During the third quarter, same-store retail unit sales decreased 11% when compared to prior year due to production timing and delivery delays in calendar year 2022, resulting in higher-than-normal retail sales later in the year. However, same-store gross profit increased 6% as gross margin increased on both new and used truck sales. Service and parts represented 65% of total gross profit and covered 132% of fixed costs in the third quarter. Q3 EBT increased 16% to a record $61 million and was the highest EBT quarter in the company history.

As we look forward to 2024, our order book recently opened and we are securing orders and expect another strong year of Class 8 sales. There’s also good news on the freight front. After nearly two years of declining freight rates, a recovery is also forecasted in calendar year 2024. Lastly, I’d like to congratulate the team at Premier Truck Group for being recognized as the Truck Dealer of the Year for 2023 for its — in its areas of customer responsiveness, workforce improvement and civic engagement. I would now like to turn the call over to Shelley Hulgrave.

Shelley Hulgrave: Thank you, Rich. Good afternoon, everyone. I would now like to walk you through several key financial highlights and discuss the strength of our balance sheet. We continue to focus on operational efficiencies through cost reductions, automation and other improvements gained over the last several years to help us maintain lower levels of SG&A to gross profit than historical averages. SG&A to gross profit was 69.9% in the third quarter and is 800 basis points below the 77.9% in 2019. SG&A includes costs related to hail damage sustained during the quarter, which represented approximately 50 basis points of SG&A to gross profit. As a result of our efforts to gain efficiencies and control expenses in our U.S. automotive operations, compensation to gross profit ratio has improved by 30 basis points, while service and parts absorption has improved 240 basis points when compared to last year.

Looking at our cash flow. We generated over $1 billion in cash flow from operations in the nine months ended September 30, 2023. During this period, we repurchased 2.7 million shares for $365 million and returned $136 million in dividends to our shareholders. Last week, we increased the dividend by almost 10% to $0.79 per share. So far this year, we have increased the cash dividend by 39% from $0.57 to $0.79. We continue to maintain a disciplined and balanced approach to capital allocation. Year-to-date, we have acquired $320 million in estimated annualized revenue and we have a pipeline of more than $2.5 billion under consideration. For the first nine months of 2023, 36% of our cash flow from operations funded share repurchases, 27% went to CapEx for growth and expansion, 21% to acquisitions and 13% to dividends.

The remaining 3% of our cash flow from operations was used to repay non-trade floor plan. Our trailing 12-month EBITDA is nearly $1.8 billion. At the end of the quarter, our long-term debt was $1.7 billion. Approximately $1 billion of the long-term debt represents our subordinated notes with $550 million maturing in 2025 and the other $500 million maturing in 2029. The average interest rate on these notes is 3.6%. We also have $504 million in mortgages and $160 million in other borrowings at subsidiaries. Debt-to-total capitalization improved to 27.3% from 28.3% at the end of the second quarter. Leverage sits at 1x at the end of September. We also have the ability to flex our leverage up to 4x on a lease-adjusted basis, leaving significant opportunity for acquisitions and returning capital to shareholders.

Our U.S. credit agreement provides for up to $1.2 billion in revolving loans for working capital, acquisitions, capital expenditures, investments and other corporate purposes and was fully available at the end of September. At September 30th, we had $104 million in cash, $415 million in vehicle equity and $1.4 billion in availability under our credit agreement. Total inventory was $3.7 billion, representing an increase of $200 million from December 31st. Floor plan debt was $3 billion. We had a 34-day supply of new vehicles, including 30 days in the U.S. and 34 days in the U.K. Days supply of new vehicles for premium was 37 and volume foreign was 19. Our current days supply of new battery electric vehicles is 52 days in the U.S. and 38 days in the U.K. Used vehicle inventory had a 38-day supply.

At this time, I will turn the call back to Roger for some final remarks.

Roger Penske: Yeah. Thank you, Shelley. She mentioned our balance sheet is strong, safe and secure, obviously, with a capitalization ratio of 27% and a leverage ratio of 1.0x, we have the ability to flex our balance sheet to maximize capital allocation. As we said earlier, since 2018, we returned over $2.5 billion to our shareholders. For nine months ended September 30, 2023, we generated $1.2 billion in earnings before taxes and that’s approximately, if you can believe it, double the earnings before taxes we generated for the full year in 2019. I think our results continue to demonstrate the benefit of our diversification across retail, automotive, commercial truck industries, cost control and a disciplined capital allocation strategy.

We continue to challenge our cost while focusing on simplification and optimization and digitization to drive efficiency. I remain confident in our model and the performance of the business. Thanks for joining us today. I look forward to your questions.

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Q&A Session

Operator: [Operator Instructions] And our first question is from John Murphy. Please go ahead.

John Murphy: Good afternoon, Roger and team.

Roger Penske: Hi, John.

John Murphy: Just a first question. You guys talked about this a bit and Shelley gave us some numbers. But as far as inventory levels, as we think about the light vehicle business in the U.S. and the U.K., how much were you hampered by shortages? I mean some of the numbers don’t sound too bad and I think people are thinking that chip shortage is done, but reality is I think there’s some — the hiccups still there. And then on the commercial side as well, I mean, it sounds like you got real shortages there. When do you think those get resolved, it will take some time and what kind of impacts are these having on the business?

Roger Penske: Okay. Let’s — I put it in perspective, John. Our total inventory at the end of nine months only went up $200 million. So, obviously, we are still in a tight inventory situation. And then the impact in the third quarter because it’s a registration month, in the U.K., almost 500 units that hit us there, obviously, that had some impact. And I think that at this point, we look at U.S. inventory today, is at 2 million units and pre-pandemic is at 3.6 million. And our inventory, obviously, is only up, I don’t know what it is on a cost for sale, but obviously, it’s not much when you look at nine months. But I think right now, remember, we are premium, so we don’t get the big swings in the domestics that they might have in the other companies and our volume foreign, obviously, Toyota is one of our lowest day supply along with Honda and it continues to be there.

So anyhow, I will let Rich talk about, Rich, what do you think about the truck inventory, where you see it as we go forward on heavy trucks.

Rich Shearing: Yeah. John, just clarification on comps. So we have seen a steadier supply this year of the Commercial Trucks. The comparison to the third quarter of last year was related to the peak end supply chain challenges at the beginning of 2022, mostly related to semiconductors and the commercial vehicles from a production standpoint and so that — those delays early last year pushed more retail sales into the third quarter and fourth quarter of last year than what would have, say, normally occurred. And so now that we are back to a more normal and even distribution of delivery from the OEMs, the comps look — in comparison were down compared to Q3 of last year. So from an inventory standpoint, we are still, as I said, sold out on every truck that’s being given to us.

We have had minor cancellations that have been sucked up by other customers who haven’t got enough trucks over the last couple of years. And we are seeing the delays come down in body builders. This is a cab chassis manufacturing that goes to some sort of body company after the fact their supply chain is improving somewhat as well. And then if you look at overall Commercial Truck inventory, just from a numbers perspective, we ended last year at 506 million in inventory and we are at 494 million today. So fairly flat across the Board.

John Murphy: Okay. And then just a second one real quick. Your parts and service was particularly strong in the quarter. Roger, I don’t know if you can talk about sort of the different channels, customer pay, warranty. I may have missed some of those numbers. But how should we think about that going forward, because that remains a significant bright spot for the business and it seems like there’s even more opportunity going forward.

Roger Penske: Well, I think, the same truck saw same-store is really meaningful. Revenue was up 9.5% and our gross profit was up 10.3%. And I think the key thing here is that, we are implementing AI that’s driving higher after-hour appointments, which we didn’t have before. Tech Video, in fact, 74% of our roads in the West are using Tech Video now. So we are not only getting better clarification of the service but also ability to upsell. And then our ELR, our rate of — that we charge the customer effective labor rate is up 5%. And we don’t see BEV also not being a detriment to our fixed. In fact, it’s really better right now because the parts costs are higher and many of these cars have to be in the shop for a longer period of time. So I think the other good news is that our tech count is up 4% in the U.S. and 3% up overall.

John Murphy: And just one follow-up on that. The ELR for warranty work, is that up in a similar rate or is that difference between customer pay and warranty…

Roger Penske: Well, no, you are – the — I would say the warranty rate is, we have to go to the manufacturer at least on a 12 months to 18 months and we have to show established door rate, then they give us a rate. So we probably could move the door rate to the customer higher faster than we would get it from the OEM, but it somewhat follows that continuously.

John Murphy: Okay. That’s very helpful. Thank you very much.

Roger Penske: All right. Thanks, John.

Operator: Next we will go to the line of Michael Ward. Please go ahead.

Roger Penske: Hey, Mike.

Michael Ward: Hey, Roger. Thanks very much for doing the call. So it looks like, basically, some of the supply constraints on the heavy-duty truck side are hitting you both on PTS and auto retail truck. And I am just curious on PTS. If I did my math right, the fleet — the managed fleet has grown about 8% annually over the last decade. Is there any reason we won’t continue to see that type of growth? And then you have also had exponential growth in the profitability, despite it being down year-over-year for some quirky things. But is that what we can expect from PTS going forward?

Roger Penske: Well, I can say this. I think I have said it on the call, we want to be at 500,000 units by 2025. Now that will move up and down a little bit on rental utilization, because right now, we are at 18,000, say, tractors in the rental fleet, probably, moving it down to, say, 14,000 here while we go through a little slower period to maintain our 80% to 85% utilization. But I see no reason not to continue the continued growth and now that’s a mix. Remember now, the straight trucks, light-duty trucks, tractors and trailers, and I think the — our tractor fleet is the biggest in the world right now and we continue to grow. The problem is from our main vendors is getting the equipment. And their –we give — one gives us trucks and the next one has a stop sale, et cetera.