PENSKE AUTOMOTIVE GROUP, INC. quarterly report, Q2 FY2019

Penske Automotive Group, Inc. — 2019 Q2 Form 10-Q

Reporting period: Three and six months ended June 30, 2019; filed July 31, 2019. The company operates automotive and commercial truck dealerships in the United States, Canada, and Western Europe, and distributes commercial vehicles, engines, power systems, parts, and services in Australia and New Zealand. At June 30, 2019, it operated 334 retail automotive franchises, 19 Premier Truck Group locations, and 14 used-vehicle supercenters.

Financial results and key metrics

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Total revenue	$5,755.8 million	$5,940.3 million	$11,320.2 million	$11,687.2 million
Gross profit	$867.8 million	$889.8 million	$1,719.3 million	$1,754.2 million
Gross margin	15.1%	15.0%	15.2%	15.0%
Operating income	$171.8 million	$188.7 million	$330.5 million	$364.4 million
Operating margin	3.0%	3.2%	2.9%	3.1%
Net income attributable to PAG common stockholders	$117.8 million	$134.6 million	$218.0 million	$242.7 million
Diluted EPS	$1.42	$1.58	$2.61	$2.84
Net cash from continuing operating activities	Not separately presented	Not separately presented	$304.6 million	$417.0 million

Retail automotive revenue declined 4.8% in the quarter and 4.3% year to date, primarily from lower new- and used-vehicle sales.
Retail commercial truck revenue increased 26.0% in the quarter and 20.3% year to date, driven by higher new-truck unit sales.
Commercial vehicle distribution and other revenue declined 9.1% in the quarter and 10.1% year to date.
Equity in earnings of affiliates increased to $39.5 million in Q2 and $66.3 million year to date, including $63.8 million from Penske Truck Leasing for the six-month period.
SG&A declined 1.0% in Q2 and 0.2% year to date, but increased as a percentage of gross profit to 77.1% and 77.7%, respectively.
Cash dividends were $0.39 per share in Q2 and $0.77 per share year to date.

Financial position, debt, liquidity, and cash flow

Cash and cash equivalents were $43.8 million at June 30, 2019, versus $39.4 million at December 31, 2018.
Total assets were $13.36 billion and total liabilities were $10.70 billion. The balance sheet includes $2.38 billion of operating lease right-of-use assets and $2.33 billion of long-term operating lease liabilities following adoption of ASC 842.
Total long-term debt was $2.23 billion, including $93.3 million current and $2.13 billion noncurrent. Major obligations include senior subordinated notes due 2020, 2022, 2024, and 2026, mortgage facilities of $402.1 million, and $92.7 million under the U.K. revolving facility.
No borrowings were outstanding under the $700 million U.S. revolving credit line at quarter-end. Available borrowing capacity was $700.0 million under the U.S. facility, approximately $110.5 million under the U.K. facility, and approximately $35.1 million under the Australian working-capital facility.
Six-month investing cash outflows were $122.0 million, including $134.5 million of capital expenditures. Acquisition spending was $1.1 million, compared with $168.6 million in 2018.
Six-month financing cash outflows were $178.1 million, including $130.6 million of share repurchases and $64.5 million of dividends.
Management stated that operating cash flow, joint-venture distributions, credit facilities, and floor-plan financing should fund existing operations and commitments for at least the next twelve months, subject to covenant compliance and financing availability.

Material changes versus the prior comparable period

Revenue decreased 3.1% in both Q2 and the first six months; gross profit decreased 2.5% and 2.0%, respectively.
New retail automotive units declined 9.7% in Q2 and 9.0% year to date on a total basis; same-store units declined 9.0% and 8.8%. New-vehicle gross profit per unit improved, but total new-vehicle gross profit declined.
Used retail automotive gross profit declined 9.7% in Q2 and 12.5% year to date; same-store gross profit per used vehicle fell 9.1% in Q2 and 11.1% year to date.
Automotive service and parts revenue increased 0.5% in Q2 and 1.8% year to date, with year-to-date gross profit up 2.1%.
New commercial truck units increased 31.0% in Q2 and 23.3% year to date, producing year-to-date new-truck revenue growth of 32.1% and gross-profit growth of 35.8%.
Unfavorable foreign-currency movements reduced Q2 revenue and gross profit by approximately $147.9 million and $20.9 million, respectively, and reduced year-to-date revenue and gross profit by approximately $328.5 million and $46.8 million.
Equity earnings increased 24.4% year to date, partly reflecting a $3.3 million benefit from the favorable affirmation of a PTL litigation position.
The company adopted ASC 842 on January 1, 2019, recognizing $2.43 billion of operating lease right-of-use assets and recording an approximately $5.0 million after-tax cumulative adjustment to retained earnings. The adoption did not materially affect income or cash flows.
PAG repurchased 2.85 million shares for $125.7 million under its repurchase program during the first six months; $74.4 million remained authorized at June 30.

Outlook, commentary, risks, and unusual items

Management described the U.S. new-vehicle market as strong but plateauing, with risks from affordability, interest rates, consumer confidence, incentives, lease returns, tariffs, and vehicle availability.
U.K. operations face Brexit-related economic and political uncertainty, declining new-vehicle registrations, used-vehicle oversupply, diesel-related regulatory pressure, and product availability constraints related to WLTP and RDE standards.
Management expected North American Class 8 truck demand to remain strong through 2019, supported by economic conditions, freight metrics, and utilization.
Management expected PTL to benefit from demand for truck leasing, rental, maintenance, and logistics outsourcing, while anticipating slower freight growth during the remainder of 2019.
Key risks include vehicle-cycle volatility, manufacturer and franchise dependence, foreign exchange, tariffs, interest-rate increases, floor-plan financing availability, debt and lease covenants, acquisitions, litigation, cybersecurity, regulatory changes, and changing vehicle technology.
A 100-basis-point interest-rate change was estimated to affect annual other interest expense by approximately $1.6 million and annual floor-plan interest expense by approximately $35.3 million.
A 10% change in average foreign-exchange rates versus the U.S. dollar would have changed six-month revenue by approximately $505.2 million.
The company reported no legal proceedings reasonably expected to have a material adverse effect, while noting that unfavorable outcomes could nevertheless be material. It had $31.6 million of letters of credit and $20.5 million of surety bonds outstanding.
In July 2019, after quarter-end, Premier Truck Group acquired Warner Truck Centers, adding six locations in Utah and Idaho.

Investor verification items

Verify the sustainability of used-vehicle gross margins, particularly in the U.K., and the effect of vehicle oversupply on inventory values.
Assess whether strong commercial truck demand offsets continued weakness in retail automotive unit volumes.
Review PTL’s earnings, distributions, leverage, and the nonrecurring litigation benefit included in 2019 equity earnings.
Monitor foreign exchange, Brexit, tariffs, emissions rules, and vehicle supply constraints affecting international operations.
Evaluate variable-rate exposure, floor-plan financing availability, debt maturities, lease obligations, and compliance with financial covenants.
Reconcile operating cash flow with floor-plan financing classifications; cash flow including all floor-plan notes payable was $311.4 million for the first six months of 2019 versus $324.1 million in 2018.
Confirm the financial and operating impact of the Warner Truck Centers acquisition and other dealership disposals or acquisitions after the reporting date.