PENSKE AUTOMOTIVE GROUP, INC. annual report, FY2018

Penske Automotive Group, Inc. — 2018 Form 10-K Summary

Business context and reporting period

The filing covers the fiscal year ended December 31, 2018; it is an annual Form 10-K rather than a quarterly filing. 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 28.9% of Penske Truck Leasing Co., L.P. The company employed nearly 27,000 people and operated 345 automotive franchises and 20 commercial truck locations at year-end.

Retail automotive dealerships generated 91.5% of consolidated revenue and 89.6% of gross profit.
Geographic revenue mix was approximately 56% United States, 35% United Kingdom, 6% Germany/Italy, 1% Canada and 2% Australia/New Zealand/Pacific.
Premium brands represented approximately 70% of retail automotive dealership revenue.

Financial performance and key metrics

Metric	2018	2017	Change
Total revenue	$22,785.1 million	$21,386.9 million	+6.5%
Gross profit	$3,414.9 million	$3,222.5 million	+6.0%
Operating income	$664.9 million	$611.4 million	+8.7%
Income from continuing operations attributable to common stockholders	$470.5 million	$613.5 million	-23.3%
Net income attributable to common stockholders	$471.0 million	$613.3 million	-23.2%
Diluted EPS from continuing operations	$5.52	$7.14	-22.7%
Net cash from continuing operating activities	$614.2 million	$623.0 million	-1.4%

Calculated consolidated margins were approximately 15.0% gross, 2.9% operating and 2.1% net in 2018. The decline in net income and EPS primarily reflects the comparison with the $243.4 million tax benefit recognized in 2017 from the U.S. Tax Cuts and Jobs Act. Excluding that comparison effect, 2018 earnings were supported by higher operating income and equity earnings.

Retail automotive revenue increased to $20,849.2 million from $19,824.3 million. Used vehicle revenue increased 13.5% to $7,252.1 million, finance and insurance revenue increased 8.2% to $629.6 million, and service and parts revenue increased 4.6% to $2,151.4 million.
New automotive retail units declined 5.1% to 235,964, but average revenue per new vehicle increased 5.3% to $40,966.
Used automotive retail units increased 11.7% to 282,542, with same-store used units up 2.0% and same-store used gross profit up 8.1%.
Retail commercial truck revenue increased 31.2% to $1,374.5 million, driven by a 39.3% increase in new truck units to 8,291 and a 37.8% same-store increase.
Commercial vehicle distribution and other revenue increased 9.1% to $561.4 million; reported gross profit increased 10.2% to $144.6 million.
Equity in earnings of affiliates increased 25.3% to $134.8 million, including $129.5 million from PTL.

Liquidity, debt and capital allocation

Cash and cash equivalents were $39.4 million at December 31, 2018, compared with $45.7 million at year-end 2017. Reported working capital was $46.9 million.
Available borrowing capacity included $670.0 million under the U.S. credit agreement, £30.6 million under the U.K. agreement and AU$41.4 million under the Australian working capital agreement.
Floor plan notes payable totaled $3,790.8 million, and total debt excluding floor plan notes payable was $2,216.7 million.
Major debt included $1,637.4 million of senior subordinated notes, $195.1 million of revolving and overdraft borrowings, $289.6 million of mortgage facilities and other Australian and miscellaneous debt.
Operating lease commitments totaled approximately $5.4 billion, including reasonably assured extension periods. The company estimated that adoption of ASC 842 in 2019 would increase lease liabilities and right-of-use assets by approximately $2.4 billion.
Capital expenditures were $305.6 million; cash used for acquisitions and other investments was $309.1 million; and proceeds from dealership sales were $84.5 million.
The company repurchased 1,587,494 shares for $68.9 million and paid $121.2 million of dividends in 2018. Dividends increased quarterly during the year, reaching $0.38 per share declared for payment on March 1, 2019.

Material changes versus the prior comparable period

Revenue and gross profit increased 6.5% and 6.0%, respectively, with reported foreign currency movements contributing $354.3 million of revenue and $44.9 million of gross profit growth.
Operating income increased despite higher SG&A, depreciation and interest expense. SG&A increased 5.2% to $2,646.3 million, floor plan interest expense increased 27.6% to $80.9 million and other interest expense increased 6.8% to $114.7 million.
New automotive volume weakened, particularly internationally, while used vehicles, finance and insurance, service and parts, commercial trucks and distribution operations improved.
The company acquired The Car People in the United Kingdom, six automotive franchises and one commercial truck dealership; it also acquired an additional 11.4% interest in the Jacobs Group, increasing ownership to 79.4%.
The company disposed of seven automotive franchises and one commercial truck dealership. These divestitures remained in continuing operations under the applicable accounting criteria.
Penske adopted ASC 606 using the modified retrospective method, increasing retained earnings by $6.6 million at January 1, 2018. The reported 2018 revenue impact was $6.7 million and the net income impact was $2.0 million.
Other comprehensive income declined by $89.5 million, principally due to a $75.8 million foreign currency translation loss.

Guidance, outlook, risks and unusual items

Management did not provide formal numerical earnings or revenue guidance in the filing. The company expected generally favorable conditions in 2019 for North American Class 8 trucks, used vehicles, Australian and New Zealand commercial vehicle markets, and PTL logistics and leasing services, although it anticipated slower freight growth.

U.S. light vehicle sales were described as strong but plateauing; management identified interest rates, credit availability, incentives, tariffs, tax policy, consumer confidence and lease returns as important variables.
United Kingdom and European operations faced weaker registrations, diesel-related demand shifts, product shortages associated with WLTP emissions testing and uncertainty surrounding Brexit.
Key financial risks include substantial variable-rate debt and floor plan financing, manufacturer dependence, vehicle recalls and supply disruptions, foreign currency exposure, economic cyclicality, competition from online sellers, and potential impairment of goodwill or franchise intangibles.
A 100-basis-point interest-rate change was estimated to affect annual other interest expense by approximately $2.0 million and floor plan interest expense by approximately $35.4 million.
A 10% change in average exchange rates against the U.S. dollar would have changed 2018 revenue by approximately $1,017.7 million.
The company recorded an $11.6 million tax benefit related to finalization of its Tax Cuts and Jobs Act estimates and a $4.0 million after-tax net benefit from dealership sale gains and valuation adjustments. It also recorded $5.8 million of impairment charges on certain indefinite-lived dealership-related intangible assets.
Legal proceedings were not expected to have a material effect individually or in the aggregate, but unfavorable outcomes remain possible. The company also had approximately $233.7 million of potential lease obligations related to sold, relocated or closed franchises if subtenants or buyers fail to perform.
Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2018.

Important facts for investors to verify

Reconcile 2018 earnings and EPS with the unusually large 2017 Tax Cuts and Jobs Act benefit.
Assess sustainability of used vehicle, finance and insurance, service and parts, and commercial truck growth as new automotive volumes declined.
Review debt maturities, variable-rate exposure, floor plan availability and compliance with credit agreement covenants.
Evaluate the effect of ASC 842, including the estimated $2.4 billion increase in recognized lease liabilities and right-of-use assets.
Monitor Brexit, WLTP-related vehicle availability, diesel demand, tariffs and foreign exchange effects on the U.K. business.
Review PTL’s earnings, distributions, leverage and restrictions on partner distributions, because PTL contributed $129.5 million of equity earnings and $63.2 million of cash distributions in 2018.
Examine acquisition integration, dealership divestitures, intangible-asset impairment assumptions and the company’s ability to fund capital allocation while maintaining liquidity.