PENSKE AUTOMOTIVE GROUP, INC. quarterly report, Q3 FY2020

Penske Automotive Group, Inc. — Q3 2020 Form 10-Q Summary

Business context and reporting period

Penske Automotive Group is a diversified international transportation services company operating 311 retail automotive franchises, 25 commercial truck dealership locations, commercial vehicle distribution operations in Australia and New Zealand, and a 28.9% equity-method investment in Penske Transportation Solutions. The filing covers the three and nine months ended September 30, 2020; comparisons are with the corresponding 2019 periods.

Operations were materially affected by COVID-19, including prior showroom closures, manufacturer production interruptions, reduced inventory, lower unit volumes, government assistance, workforce reductions, and cost controls. Most locations had reopened by the third quarter, although certain U.K. dealerships were again subject to restrictions in October 2020.

Key financial metrics

Metric	Q3 2020	Q3 2019	9M 2020	9M 2019
Total revenue	$5,971.6 million	$5,967.6 million	$14,631.8 million	$17,287.8 million
Gross profit	$956.5 million	$869.7 million	$2,286.1 million	$2,589.0 million
Operating income	$284.2 million	$169.4 million	$462.0 million	$499.9 million
Net income attributable to PAG stockholders	$246.6 million	$116.2 million	$343.4 million	$334.2 million
Diluted EPS	$3.07	$1.42	$4.27	$4.03
Gross margin	16.0%	14.6%	15.6%	15.0%
Operating margin	4.8%	2.8%	3.2%	2.9%

Q3 revenue was essentially flat year over year, while gross profit increased 10.0% and operating income increased 67.8%. Nine-month revenue declined 15.4%, gross profit declined 11.7%, and operating income declined 7.6%. The filing attributes the third-quarter margin improvement primarily to higher gross profit per vehicle, lower SG&A, reduced floor plan interest, favorable foreign currency effects, and improved PTS results.

Q3 retail automotive revenue increased 2.0% to $5,258.0 million, despite same-store new and used unit declines of 5.8% and 3.6%, respectively.
Q3 new-vehicle gross profit per unit increased 27.8% to $3,670; used-vehicle gross profit per unit increased 67.3% to $2,024.
Q3 retail commercial truck revenue declined 14.7% to $590.9 million, reflecting lower new-truck volume and a 31.0% decline in the North American Class 6–8 market.
Equity in earnings of affiliates increased 52.9% in Q3 to $66.2 million. PTS contributed $108.0 million of PAG equity earnings for the first nine months, compared with $106.0 million in 2019.
SG&A declined 4.4% in Q3 to $643.3 million, and SG&A as a percentage of gross profit improved to 67.3% from 77.4%.
Income taxes included a $15.4 million benefit from the CARES Act and other U.S. and foreign tax legislation changes. The effective tax rate was 20.6% in Q3 and 22.7% for the nine months.

Cash flow, debt, and liquidity

Net cash from continuing operating activities was $849.5 million for the first nine months, compared with $660.8 million in 2019. The 2020 amount benefited from working-capital movements, floor plan interest and other COVID-19-related deferrals. Excluding non-trade floor plan changes, operating cash flow was $301.9 million versus $642.8 million in 2019.
Capital expenditures were $114.3 million, down from $188.8 million. Management postponed or eliminated an estimated $150 million of capital expenditures.
Net cash used in financing activities was $704.3 million, including $547.6 million of non-trade floor plan repayments, $34.2 million of dividends, $29.4 million of share repurchases, and debt refinancing activity.
Cash and cash equivalents were $92.7 million at September 30, 2020, compared with $28.1 million at December 31, 2019.
Total long-term debt was $2,301.7 million, including $2,216.1 million net of the current portion. Total floor plan notes payable were $2,530.4 million, comprising $1,484.0 million of trade floor plan debt and $1,046.4 million of non-trade floor plan debt.
Revolving availability was approximately $1.0 billion, including $800.0 million under the U.S. facility, £162.0 million under the U.K. facility, and AU$50.0 million under the Australian working-capital facility. No U.S. or U.K. revolver borrowings were outstanding at quarter-end.
PAG issued $550 million of 3.50% senior subordinated notes due 2025 in August 2020 and used the proceeds to redeem $550 million of 5.75% notes due 2022 on October 1, 2020. It also repaid $300 million of notes at scheduled maturity during the third quarter.
Management stated that the company was in compliance with debt and operating-lease covenants and expected to remain compliant for the next twelve months.

Material changes versus the prior comparable period

COVID-19 caused a sharp first-half contraction, but reopening and improved vehicle pricing produced substantially stronger Q3 profitability.
Retail automotive unit volumes remained below prior-year levels, but limited inventory and manufacturer incentives materially increased new- and used-vehicle gross profit per unit.
Nine-month retail automotive revenue declined 16.9%, while retail automotive gross profit declined only 1.1%, reflecting improved margins and product mix.
Retail commercial truck revenue increased 2.1% for the first nine months, primarily because of 2019 acquisitions, but same-store new-truck revenue declined 22.9% and used-truck gross profit fell sharply.
Commercial vehicle distribution revenue declined 18.1% and gross profit declined 14.9% for the first nine months.
Common shares outstanding declined to approximately 80.3 million from 81.1 million at year-end 2019. PAG repurchased $29.4 million of common stock during the first nine months, but made no program repurchases during Q2 or Q3.
The quarterly dividend was suspended in May 2020 after a $0.42 per-share payment in Q1. On October 14, 2020, PAG announced reinstatement of a $0.42 per-share dividend payable December 1, 2020.

Guidance, outlook, risks, and unusual items

Management expected more normalized U.S. and U.K. vehicle sales in Q4, assuming moderate pandemic conditions, no broad reinstatement of shelter-in-place orders, and improved vehicle availability. It expected similar fourth-quarter performance for commercial trucks and continued resilient PTS performance under the same assumptions.
Management estimated that the U.S. light-vehicle market could produce a similar seasonally adjusted annual rate to September’s 16.4 million units during Q4. It also estimated 2020 North American Class 8 retail sales of approximately 220,000 units.
Key risks include renewed COVID-19 closures, uncertain customer demand, manufacturer production and inventory constraints, reduced workforce availability, liquidity and covenant compliance, variable interest rates, and the ability to refinance debt.
Brexit could increase import duties, border delays, vehicle and parts costs, foreign-exchange volatility, and pressure on U.K. demand. The filing notes that a no-trade-agreement scenario could result in a 10% import duty on vehicles imported into the U.K.
U.K. Financial Conduct Authority rules effective January 28, 2021 could restrict certain dealer compensation related to financing and insurance products.
PAG has approximately $5.4 billion of undiscounted future operating lease payments, $49.0 million of letters of credit, and $21.8 million of surety bonds. Management does not expect currently disclosed litigation to have a material adverse effect, but unfavorable outcomes remain possible.
A 100-basis-point change in interest rates was estimated to affect annual floor plan interest expense by approximately $33.0 million. A 10% change in average foreign exchange rates versus the U.S. dollar would have changed nine-month revenue by approximately $601.5 million.

Important facts for investors to verify

Whether Q4 and subsequent vehicle volumes recover as projected and whether unusually high vehicle gross profit per unit is sustainable as inventory normalizes.
The effect of renewed COVID-19 restrictions, particularly in the U.K., on showroom activity, service operations, staffing, and manufacturer supply.
Underlying operating cash generation after separating non-trade floor plan movements and temporary payment deferrals.
Debt maturity, refinancing, covenant compliance, revolver availability, and exposure to variable interest rates and LIBOR transition.
The sustainability of PTS earnings and cash distributions, including the impact of its utilization, logistics, remarketing, and customer credit conditions.
The effect of the dividend reinstatement, future repurchases, and planned Used Vehicle SuperCenter openings on liquidity and capital allocation.
Potential effects of Brexit, U.K. financing-compensation regulations, emissions rules, privacy regulation, and other regulatory changes.