Penske Automotive Group, Inc. — 2018 Q3 Form 10-Q Summary
Business Context and Reporting Period
Unaudited quarterly report for the three and nine months ended September 30, 2018, filed October 26, 2018. PAG operates automotive and commercial truck dealerships primarily in the United States, Canada, and Western Europe, and distributes commercial vehicles, engines, power systems, parts, and services in Australia and New Zealand. It also owns a 28.9% equity-method interest in Penske Truck Leasing.
- As of September 30, 2018: 342 retail automotive franchises, 21 Premier Truck Group locations, and 14 stand-alone used-vehicle dealerships.
- Nine-month retail automotive revenue was generated 54% in the U.S. and Puerto Rico and 46% internationally; 69% came from premium brands.
Key Financial Metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenue | $5,658.6 million | $5,524.4 million | $17,345.8 million | $15,988.9 million |
| Gross profit | $852.6 million | $822.6 million | $2,606.8 million | $2,414.2 million |
| Operating income | $163.9 million | $152.2 million | $528.3 million | $474.4 million |
| Net income attributable to PAG common stockholders | $130.2 million | $94.4 million | $372.9 million | $283.2 million |
| Diluted EPS | $1.53 | $1.10 | $4.37 | $3.30 |
| Cash dividends per share | $0.36 | $0.32 | $1.05 | $0.93 |
- Q3 revenue increased 2.4%; gross profit increased 3.6%; operating income increased 7.7%; and diluted EPS increased 39.1%.
- Nine-month revenue increased 8.5%; gross profit increased 8.0%; operating income increased 11.4%; and diluted EPS increased 32.4%.
- Approximate margins: Q3 gross margin 15.1%, operating margin 2.9%, and net margin attributable to PAG 2.3%. Nine-month gross margin was 15.0%, operating margin 3.0%, and net margin attributable to PAG 2.1%.
- Equity in earnings of affiliates increased to $41.7 million in Q3 and $95.0 million for nine months, primarily reflecting stronger PTL results and PAG’s increased PTL ownership.
Cash Flow, Debt, and Liquidity
- Nine-month cash flow from continuing operations was $535.9 million, compared with $466.8 million in 2017. Including non-trade floor-plan financing as an operating activity, cash flow was $476.3 million versus $622.0 million.
- Cash used in investing activities was $291.5 million, including $188.5 million of capital expenditures and $168.6 million for acquisitions, partially offset by $58.4 million of dealership-sale proceeds.
- Cash used in financing activities was $252.3 million, including $55.8 million of share repurchases, $89.7 million of dividends, $59.6 million of non-trade floor-plan repayments, and $41.0 million of net long-term debt repayments.
- Cash and cash equivalents declined to $37.6 million at September 30, 2018 from $45.7 million at December 31, 2017. Reported working capital was $40.3 million.
- Total long-term debt was $2,086.0 million, including $1,993.3 million classified as noncurrent. Floor-plan notes payable totaled $3,528.5 million, consisting of $2,169.5 million of trade floor-plan debt and $1,359.0 million of non-trade floor-plan debt.
- Available borrowing capacity was $700.0 million under the U.S. credit agreement, approximately $99.0 million under the U.K. facility, and approximately $30.3 million under the Australian working-capital facility. The U.S. revolver had no borrowings outstanding at quarter-end.
- Management stated that the company was in compliance with debt and lease covenants and expected existing operating cash flow, distributions, and available financing to fund operations and commitments for at least the next twelve months.
Material Changes Versus the Prior Comparable Period
- Retail automotive revenue increased to $15.9 billion for nine months, driven especially by used vehicles, finance and insurance, and service and parts. New-vehicle units declined 4.3%, while used-vehicle units increased 12.3%.
- Retail commercial truck revenue increased 37.4% for nine months, with new truck units up 50.4% and used truck units up 23.3%, supported by strong North American truck markets.
- Commercial vehicle distribution and other revenue increased 17.1% for nine months. PPS revenue increased 49.5%, while PCV Australia revenue declined 11.5% because of operational integration and product-routing changes; PCV Australia gross profit nevertheless increased.
- SG&A increased 7.0% for nine months, below the 8.0% increase in gross profit, reducing SG&A as a percentage of gross profit to 76.8% from 77.5%.
- Floor-plan interest expense increased 29.4% for nine months, primarily from higher applicable interest rates. Other interest expense increased 9.5%.
- Foreign-currency movements increased reported nine-month revenue by $429.3 million and gross profit by $56.0 million, while reducing Q3 revenue by $26.2 million and gross profit by $4.7 million.
- PAG acquired The Car People in the U.K., four Italian automotive franchises, and one Canadian commercial truck dealership; it also disposed of six retail automotive franchises. Cash acquisitions totaled $168.6 million versus $449.7 million in the prior-year period.
Guidance, Outlook, Risks, and Unusual Items
- Management expected continued strength in U.S. used vehicles, commercial trucks in North America, Australian and New Zealand truck markets, and PTL’s leasing, rental, maintenance, and logistics businesses.
- Management characterized the U.S. new-light-vehicle market as strong but plateauing. Risks cited include interest rates, consumer confidence, incentives, credit availability, tariffs, vehicle supply, lease returns, and tax-policy changes.
- U.K. operations faced weaker registrations, product availability disruptions related to WLTP emissions testing, uncertainty around diesel vehicles and residual values, and Brexit-related economic and political uncertainty.
- Effective January 1, 2018, PAG adopted ASC 606 using the modified retrospective method, producing a $6.6 million after-tax increase to retained earnings. The reported income statement impact was not material.
- The company finalized its accounting for the U.S. Tax Cuts and Jobs Act. A third-quarter $11.6 million tax benefit, or approximately $0.14 per share, increased the total recorded Act-related benefit to $255.0 million. The Q3 effective tax rate was 17.3% versus 32.2% in the prior-year quarter.
- Nine-month results also included a $1.0 million after-tax net benefit from dealership sales, franchise terminations, and property valuation adjustments.
- PAG expects to adopt the new lease standard on January 1, 2019. It anticipates a significant increase in reported assets and liabilities from recognizing operating lease right-of-use assets and lease liabilities.
- Material risk areas include economic and vehicle-market cyclicality, variable interest rates, foreign exchange, manufacturer and franchise dependence, tariffs, Brexit, vehicle supply disruptions, technology and electrification trends, debt and covenant compliance, information security, litigation, and PTL performance.
- The company reported $41.1 million of letters of credit and $28.7 million of surety bonds outstanding. It was not party to legal proceedings expected to have a material adverse effect, although unfavorable outcomes remain possible.
Important Facts for Investors to Verify
- Determine the portion of EPS growth attributable to the $11.6 million tax benefit and other unusual items versus recurring operating performance.
- Monitor used-vehicle growth and margins as new-vehicle unit volumes declined, particularly in the U.S. and U.K.
- Assess sensitivity to rising interest rates: management estimated that a 100-basis-point change would affect annual floor-plan interest expense by approximately $35.5 million and other interest expense by approximately $1.1 million.
- Reconcile liquidity using only $37.6 million of reported cash against substantial floor-plan financing and total long-term debt, while confirming continued credit-facility availability and covenant compliance.
- Evaluate the effect of Brexit, WLTP-related supply constraints, tariffs, currency movements, and manufacturer franchise relationships on international operations.
- Review the expected balance-sheet impact of ASC 842 lease adoption and the company’s ongoing acquisition, capital-expenditure, dividend, and share-repurchase commitments.