PENSKE AUTOMOTIVE GROUP, INC. quarterly report, Q3 FY2019

Penske Automotive Group, Inc. — Form 10-Q Summary

Business context and reporting period

Filed for the quarter ended September 30, 2019. Penske Automotive Group operates automotive and commercial truck dealerships in the United States, Canada, and Western Europe; distributes commercial vehicles, engines, and power systems in Australia and New Zealand; and owns a 28.9% equity-method interest in Penske Truck Leasing. At quarter-end, PAG operated 333 retail automotive franchises and 25 Premier Truck Group locations and employed more than 27,000 people worldwide.

Financial performance and key metrics

Metric	Three months ended September 30	Nine months ended September 30
Total revenue	$5,967.6 million, up 5.5%	$17,287.8 million, down 0.3%
Gross profit	$869.7 million, up 2.0%	$2,589.0 million, down 0.7%
Gross margin	14.6%, compared with 15.1%	15.0%, compared with 15.0%
Operating income	$169.4 million, up 3.4%	$499.9 million, down 5.4%
Net income attributable to PAG stockholders	$116.2 million, down 10.8%	$334.2 million, down 10.4%
Diluted EPS	$1.42, compared with $1.53	$4.03, compared with $4.37
Cash dividends per share	$0.40, compared with $0.36	$1.17, compared with $1.05

Reported operating margin was approximately 2.8% for the quarter and 2.9% for the nine-month period. Net margin attributable to PAG stockholders was approximately 1.9% in both periods.

Quarterly revenue growth was driven mainly by retail commercial truck dealership revenue, which increased 79.7% to $692.3 million, including the impact of acquisitions. Retail automotive revenue was broadly flat at $5,155.4 million, while commercial vehicle distribution revenue declined 3.9% to $119.9 million.
Nine-month retail automotive revenue declined 2.9% to $15,442.9 million. Retail commercial truck revenue increased 42.8% to $1,451.4 million, while commercial vehicle distribution revenue declined 8.3% to $393.5 million.
Equity in earnings of affiliates increased to $109.6 million from $95.0 million for the nine months, including $106.0 million from the PTL investment. PTL’s nine-month revenue was $6.7 billion and net income was $367 million.
Cash provided by continuing operating activities was $660.8 million, compared with $535.9 million in the prior-year period. Capital expenditures were $188.8 million and acquisition spending was $326.9 million.
Cash used in financing activities was $119.0 million, including $174.1 million of share repurchases and $97.3 million of dividends. Ending cash was $77.5 million, compared with $37.6 million at September 30, 2018.

Balance sheet, debt, and liquidity

Total assets were $13.69 billion and total equity was $2.66 billion at September 30, 2019.
Long-term debt, including the current portion, was $2.379 billion. Floor plan notes payable totaled $3.855 billion, consisting of $2.444 billion of trade floor plan debt and $1.411 billion of non-trade floor plan debt.
Operating lease right-of-use assets of $2.384 billion and operating lease liabilities of $2.423 billion were recorded following adoption of ASC 842. Undiscounted future operating lease payments totaled approximately $5.5 billion.
Available borrowing capacity was $595.0 million under the U.S. credit agreement, £34.0 million under the U.K. credit agreement, and AU$50.0 million under the Australian working capital facility.
Management stated that operating cash flow, joint-venture distributions, credit facilities, and floor plan financing should be sufficient for existing operations and commitments for at least the next twelve months. PAG was in compliance with its credit and operating lease covenants at quarter-end.

Material changes versus the prior comparable period

Nine-month revenue and profitability weakened despite growth in commercial truck operations. New retail automotive units decreased 7.0%, and same-store new units decreased 6.6%; used units were essentially flat, but same-store used gross profit declined 12.7%.
Retail automotive new-vehicle gross profit declined 7.4% for the nine months, while used-vehicle gross profit declined 13.2%. Service and parts gross profit increased 2.3%, and finance and insurance revenue increased 1.9%.
Retail commercial truck revenue increased substantially from acquisitions and strong new-truck demand. Nine-month new truck units increased 42.3%, including a 13.4% same-store increase; used truck same-store units declined 17.8%.
Foreign currency translation materially reduced reported results. Average exchange-rate changes reduced nine-month revenue by $457.6 million, gross profit by $64.5 million, and continuing-operations EPS by approximately $0.08.
Effective tax rates increased to 26.8% from 17.3% in the quarter and to 26.2% from 21.9% for the nine months. The 2018 comparison benefited from an $11.6 million tax benefit related to the Tax Cuts and Jobs Act.
Other interest expense increased 16.3% in the quarter and 7.5% for the nine months, primarily because of higher revolver and mortgage borrowings. Floor plan interest expense increased 8.8% for the nine months.
PAG acquired six retail commercial truck locations and one New Zealand commercial vehicle dealership, disposed of thirteen retail automotive franchises and one retail commercial truck location, and increased its Jacobs Group ownership to 87.8%.
During the nine months, PAG repurchased 3.9 million shares for $169.2 million under its repurchase program. Remaining repurchase authorization was $200.0 million at September 30, 2019.

Outlook, commentary, risks, and unusual items

The filing does not provide formal company revenue or earnings guidance. Management expected U.S. new vehicle markets to remain strong but plateaued, with trucks, crossovers, and SUVs continuing to outperform passenger cars.
Management expected North American Class 8 truck demand to remain strong through 2019, while citing an industry forecast for an approximately 20% decline in Class 8 sales in 2020.
Brexit, weaker U.K. consumer confidence, declining U.K. vehicle values, diesel-related regulation, and WLTP/RDE testing requirements were cited as causes of product shortages, lower volumes, and pressure on U.K. gross profit.
Key risks include economic cyclicality, interest-rate and foreign-exchange exposure, vehicle affordability and credit availability, tariffs, manufacturer and franchise dependence, product recalls or shortages, electrification and mobility changes, covenant compliance, cybersecurity, litigation, and the availability of acquisition or refinancing capital.
A 100-basis-point change in interest rates was estimated to change annual other interest expense by approximately $2.2 million and annual floor plan interest expense by approximately $35.9 million. A 10% change in average foreign exchange rates versus the U.S. dollar would have changed nine-month revenue by approximately $739.6 million.
There were no legal proceedings that management expected to have a material adverse effect individually or in the aggregate, although adverse outcomes remain possible. PAG had $42.2 million of letters of credit and $20.5 million of surety bonds outstanding.
The company adopted ASC 842 on January 1, 2019, recording lease assets and liabilities and a $5.0 million after-tax increase to retained earnings. Management reported effective disclosure controls and procedures.

Important facts for investors to verify

Whether declining automotive new- and used-vehicle margins, particularly in the U.K., persist or recover.
The earnings contribution, cash distributions, and financial condition of PTL, which represented a significant portion of PAG’s pretax income.
Integration and performance of the acquired truck dealerships and the company’s expected 2020 commercial truck market exposure.
Liquidity after share repurchases, dividends, acquisitions, capital expenditures, and scheduled or potential debt refinancing.
Compliance with credit agreement, lease, and floor plan covenants, including the effect of higher variable interest rates.
The eventual commercial, regulatory, and foreign-exchange effects of Brexit, WLTP/RDE requirements, tariffs, and changing emissions standards.
Potential exposure from litigation, lease guarantees, subleases, the Australian vehicle repurchase commitment, letters of credit, and surety bonds.