PENSKE AUTOMOTIVE GROUP, INC. annual report, FY2016

Penske Automotive Group, Inc. — FY2016 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2016. The filing is an annual Form 10-K; “2016 Q4” in the request metadata refers to the fourth quarter within the reported fiscal year. Results include continuing operations and separately reported discontinued operations.

Business context

Penske Automotive Group is an international transportation services company operating automotive and commercial truck dealerships primarily in the United States, Canada and Western Europe, with commercial vehicle, engine and power-systems distribution operations principally in Australia and New Zealand. At year-end, the company operated 355 retail automotive franchises and employed more than 24,000 people.

Retail automotive dealerships generated $18.7 billion, or 92.8% of total revenue.
Retail commercial truck dealerships generated $1.0 billion, or 5.0% of total revenue.
Commercial vehicle distribution and other operations generated $444.6 million, or approximately 2.2% of total revenue.
The company held a 23.4% equity-method interest in Penske Truck Leasing Co., L.P. (“PTL”).

Financial performance and key metrics

Metric	2016	2015	Change
Total revenue	$20,118.5 million	$19,284.9 million	+4.3%
Gross profit	$2,966.6 million	$2,867.5 million	+3.5%
Operating income	$574.9 million	$566.5 million	+1.5%
Income from continuing operations	$347.4 million	$333.9 million	+4.0%
Net income attributable to PAG common stockholders	$342.9 million	$326.1 million	+5.2%
Diluted EPS	$3.99	$3.63	+9.9%
Cash flow from continuing operating activities	$365.5 million	$391.5 million	-6.6%

Gross margin was approximately 14.8%, operating margin approximately 2.9%, and net margin attributable to common stockholders approximately 1.7%.
Equity in earnings of affiliates increased to $69.5 million from $39.3 million, primarily reflecting the increased PTL ownership interest.
Floor plan interest expense increased to $50.9 million from $44.5 million, while other interest expense increased to $85.4 million from $69.4 million.
Cash and cash equivalents declined to $24.0 million from $62.4 million.
Total assets increased to $8.86 billion from $8.01 billion, while total equity attributable to PAG common stockholders decreased to $1.75 billion from $1.79 billion.

Liquidity, debt and capital allocation

Total floor plan notes payable were $3.32 billion at December 31, 2016, including $2.08 billion of trade floor plan notes and $1.23 billion of non-trade floor plan notes.
Total debt excluding floor plan notes payable was $1.88 billion, up from $1.28 billion.
Debt included $493.7 million of 5.50% senior subordinated notes due 2026, $296.8 million of 5.375% notes due 2024 and $545.1 million of 5.75% notes due 2022.
Available borrowing capacity was $460.0 million under the U.S. credit agreement, £118.8 million under the U.K. credit agreement and AU$16.2 million under the Australian working capital agreement.
Working capital was $191.9 million, including $24.0 million of cash. Management stated that operating cash flow, distributions from joint ventures and existing financing resources were expected to fund operations and current commitments for at least the next twelve months.
Operating lease commitments totaled approximately $4.55 billion, including extension periods reasonably assured of being exercised.
The company issued $500.0 million of 5.50% senior subordinated notes in May 2016 and used the proceeds primarily to repay U.S. credit agreement and floor plan borrowings.
The company repurchased 4.5 million shares for $167.9 million and paid $95.1 million in dividends during 2016. The quarterly dividend increased to $0.30 per share payable March 1, 2017.

Material changes versus the prior comparable period

Revenue and gross profit increased, principally from net dealership acquisitions, higher vehicle, finance and insurance, and service and parts activity.
Reported growth was materially reduced by foreign exchange. Average currency-rate changes reduced 2016 revenue by approximately $827.0 million and gross profit by $107.6 million; excluding that effect, revenue increased 8.6% and gross profit 7.2%.
Same-store new vehicle units increased 1.0%, but same-store new vehicle gross profit declined 3.4% and average gross profit per vehicle declined 4.3%.
Same-store used vehicle units declined 0.4%, same-store used vehicle gross profit declined 4.8%, and used vehicle gross margin fell to 5.9% from 6.2%.
Service and parts revenue increased 6.4%, but the related gross margin declined to 58.0% from 59.2%, reflecting changes in warranty, customer-pay and geographic mix.
Premier Truck Group revenue increased to $1.0 billion, but gross profit declined to $142.9 million from $147.0 million. Same-store new truck units declined 35.0%, and used truck gross profit turned negative due to weaker demand and used-truck pricing.
Commercial vehicle distribution revenue was broadly unchanged at $444.6 million, although PCV Australia declined while Penske Power Systems improved.
Operating cash flow declined despite higher net income, while investing cash outflows rose sharply to $836.7 million, including the $498.5 million acquisition of an additional 14.4% PTL interest.
Other comprehensive loss increased to $129.0 million, primarily due to a $117.3 million foreign currency translation loss.

Guidance, outlook, risks and unusual items

Management expected U.S. light-vehicle sales to remain near 2016 levels in 2017, supported by employment, credit availability, low interest rates, leasing and vehicle replacement needs.
Management expected used-vehicle supply to benefit from increased lease returns and anticipated continued strength in the used market.
North American Class 8 truck sales were expected to decline again in 2017, although service activity was expected to remain comparatively strong as customers retained equipment longer.
Australian and New Zealand commercial vehicle markets were expected to remain below historical levels because of macroeconomic conditions and weak commodity prices; parts distribution was expected to be more resilient.
Management expected PTL to benefit from demand for outsourced fleet, leasing, maintenance and logistics services, while noting that freight weakness and excess truck capacity had affected utilization and truck sales.
Brexit created economic, foreign exchange and trade uncertainty. The U.K. represented 32% of 2016 total revenue, and the weaker pound adversely affected reported results.
Material risks include macroeconomic cyclicality, variable interest rates, substantial floor plan and lease obligations, dependence on manufacturers and franchise agreements, recalls, regulatory changes affecting finance and insurance income, foreign currency exposure, cybersecurity, environmental liabilities, litigation and the performance of PTL and other joint ventures.
At year-end, management reported compliance with debt and lease covenants. No legal proceedings were identified as reasonably expected to have a material adverse effect, although outcomes could not be predicted with certainty.
Unusual or notable items included the 2016 PTL investment, the 5.50% notes issuance, significant foreign currency translation losses, and a $5.1 million reduction in tax expense related to the acquisition of the remaining PTG ownership interests.

Investor verification checklist

Reconcile reported revenue, gross profit and EPS growth with the substantial negative foreign exchange impact and acquisition contributions.
Assess leverage and liquidity using floor plan debt, $1.88 billion of non-floor-plan debt, $4.55 billion of lease commitments and only $24.0 million of cash.
Review variable-rate exposure: a 100-basis-point change was estimated to affect annual floor plan interest expense by approximately $32.3 million and other interest expense by approximately $2.9 million.
Evaluate same-store vehicle margins, particularly the declines in new and used vehicle gross profit per unit.
Monitor Class 8 truck demand, used-truck residual values and PTG service performance.
Verify PTL distributions, earnings contribution, debt and distribution restrictions, and the strategic rationale and returns from the $498.5 million additional investment.
Review the effects of Brexit, sterling movements and other foreign currency changes on future reported results.
Review franchise renewal provisions, manufacturer concentration, CFPB and Financial Conduct Authority developments, recall exposure and cybersecurity controls.
Consider the effect of future lease accounting adoption, which management expected to materially increase reported lease assets and liabilities.