Group 1 Automotive, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; unaudited. Group 1 operates franchised dealerships in the U.S., U.K. and Brazil, selling new and used vehicles and providing finance, insurance, parts, maintenance and repair services. At quarter-end it operated 180 dealership locations and 48 collision centers.
Financial results and liquidity
Amounts below are in millions of U.S. dollars except per-share data and percentages.
| Metric | Q2 2018 | Q2 2017 | H1 2018 | H1 2017 |
|---|---|---|---|---|
| Revenue | $2,943.5 | $2,672.2 | $5,803.5 | $5,191.0 |
| Gross profit | $438.2 | $404.9 | $857.9 | $788.4 |
| Operating income | $109.2 | $92.2 | $188.2 | $172.4 |
| Net income | $56.5 | $39.1 | $92.3 | $73.1 |
| Diluted EPS | $2.72 | $1.84 | $4.42 | $3.42 |
| Gross margin | 14.9% | 15.2% | 14.8% | 15.2% |
| Operating margin | 3.7% | 3.5% | 3.2% | 3.3% |
| Pretax margin | 2.6% | 2.3% | 2.1% | 2.2% |
- Q2 revenue rose 10.2%, gross profit 8.2%, operating income 18.3%, and net income 44.3% year over year. H1 revenue increased 11.8%, gross profit 8.8%, and net income 26.3%.
- Q2 total vehicle retail units increased 11.8%; used-vehicle retail sales were a significant growth driver. Parts and service sales rose 8.0% for the quarter. Same-store new-vehicle units, however, declined 1.1%.
- H1 cash provided by operating activities was $263.1 million, versus $52.2 million a year earlier. Management’s adjusted, non-GAAP operating cash flow was $185.7 million, versus $124.8 million; the filing attributes the difference in part to floorplan cash-flow presentation and working-capital movements. Investing activities used $87.8 million and financing activities used $158.5 million. Cash, cash equivalents and restricted cash ended at $43.6 million.
- At June 30, total assets were $4.89 billion, current assets $2.27 billion and current liabilities $2.12 billion; reported working capital was $155.1 million. Cash on the balance sheet was $41.6 million, and the company also had $144.1 million of immediately available funds from floorplan paydowns.
- Long-term debt, net of current maturities, was $1.36 billion; current maturities and short-term financing were $76.4 million. Separate vehicle floorplan financing was substantial. The company reported $1.06 billion outstanding under its revolving credit facility and $144.1 million under the Ford facility, with $895.4 million of total U.S. credit-facility capacity available. The company was in compliance with credit covenants; total adjusted leverage was 3.89 against a maximum of 5.50, and fixed-charge coverage was 2.45 against a minimum of 1.20.
- Interest expense increased: Q2 floorplan interest was $14.6 million versus $13.2 million, and other interest was $19.4 million versus $17.3 million. At quarter-end, $804.6 million of swaps fixed underlying LIBOR at a weighted-average 2.6%. Management estimated a 100-basis-point rate change would affect annual interest expense by about $9.4 million after swaps, based on H1 average borrowings.
Material changes and management commentary
- Growth included acquired operations: H1 acquisitions comprised dealerships and franchises in the U.K., Brazil and U.S., for aggregate consideration of $80.0 million, including real estate and goodwill. The reported growth rate therefore is not solely same-store growth.
- Same-store total revenue increased 2.2% in Q2 and 4.1% in H1. New-vehicle retail gross margin fell to 5.0% from 5.2% in both periods; used-vehicle retail gross margin also weakened for H1. Parts and service remained a higher-margin contributor, with Q2 same-store margin of 54.4% versus 53.9%.
- The U.S. same-store used-vehicle retail unit increase was supported by the new Val-U-Line program, which shifted older, higher-mileage vehicles from wholesale auctions to retail sales. Management said this raised retail volume but reduced used-vehicle gross profit per unit.
- The effective tax rate declined to 24.9% for Q2 and 24.0% for H1, from 36.6% and 35.3%, respectively, primarily reflecting the U.S. Tax Act and lower federal corporate tax rate.
- Management cited U.S. industry new-vehicle sales growth of 1.9% for H1. U.K. industry registrations declined 6.3%, and management expected U.K. industry sales to remain volatile and lower for full-year 2018 than 2017. Brazil industry registrations increased 13.7%; management expected market conditions and sales to continue improving.
Outlook, risks and unusual items
- Management expected 2018 capital expenditures below $120 million, excluding real-estate purchases related to acquisitions and lease buyouts. It believed cash flow and borrowing capacity would be adequate for operations, capital spending and acquisitions for the remainder of 2018, subject to economic and business conditions.
- Management forecast a full-year 2018 effective tax rate of 23%–24%. It also described priorities including growing used retail and parts and service, controlling costs, integrating acquisitions and allocating capital among acquisitions, dispositions, repurchases and dividends. No specific earnings or revenue guidance was provided.
- Q2 results included a $20.1 million pretax gain on real-estate and dealership transactions, $5.8 million of same-store costs related to hailstorms, legal settlement costs, and $4.3 million in asset impairments. Management’s adjusted non-GAAP Q2 diluted EPS was $2.45 versus reported $2.72; H1 adjusted diluted EPS was $4.15 versus reported $4.42. These adjustments are management-defined non-GAAP measures.
- Foreign-exchange exposure is unhedged. The filing estimates that a 10% average-rate devaluation against the U.S. dollar would reduce H1 reported revenue by $120.7 million for sterling and $20.0 million for the Brazilian real. Other risks include interest rates, consumer demand and credit availability, manufacturer concentration and incentives, vehicle supply, tariffs and trade restrictions, weather events, regulation, cybersecurity, acquisitions and goodwill impairment.
- The company reported no legal proceedings reasonably expected to have a material adverse effect, while noting that outcomes of current or future matters cannot be predicted with certainty. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
- Topic 606 was adopted January 1, 2018 using the modified retrospective method. It increased opening retained earnings by $11.4 million; its effect on reported net income was a reduction of $0.1 million for Q2 and $0.5 million for H1 compared with results without adoption. The company expected lease accounting changes effective in 2019 to significantly affect its balance sheet because approximately half of its real estate was rented.
- The company repurchased $51.3 million of stock and paid $10.8 million in dividends during H1. It repurchased 610,752 shares in Q2 at an average $68.90; a further 367,773 shares costing $25.0 million were purchased after quarter-end under a short-term trading plan.
Investor verification priorities
- Separate acquisition, disposition and currency effects from same-store performance, especially in the U.K.; confirm whether used-vehicle retail growth and Val-U-Line margins are sustainable.
- Reconcile GAAP operating cash flow with management’s adjusted measure and assess the role of floorplan movements, inventory changes, asset-sale proceeds and working capital in cash generation.
- Review total funded debt and floorplan obligations together, interest-rate exposure and hedge coverage, available borrowing capacity, covenant headroom and restrictions on dividends or repurchases.
- Assess the durability of profit growth excluding the real-estate/dealership gain and considering hail, legal and impairment costs; verify the assumptions behind the 23%–24% tax-rate outlook.
- Monitor U.K. market weakness, sterling and Brazilian-real movements, potential vehicle and parts tariffs, and the effect of higher rates on financing costs and customer demand.