PENSKE AUTOMOTIVE GROUP, INC. annual report, FY2019

Penske Automotive Group, Inc. — FY2019 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2019. The filing includes unaudited fourth-quarter data; it is an annual Form 10-K rather than a quarterly filing.

Business Context

Penske Automotive Group is a diversified international transportation services company operating automotive and commercial truck dealerships principally in the United States, Canada and Western Europe, plus commercial vehicle, engine and power-system distribution operations in Australia and New Zealand. The company employed nearly 27,000 people and operated 321 retail automotive franchises, 16 used-vehicle supercenters and 25 Premier Truck Group locations at year-end. It also held a 28.9% equity interest in Penske Truck Leasing Co., L.P. (Penske Transportation Solutions, or PTS).

Financial Performance and Metrics

Metric	2019	2018	Change
Total revenue	$23.179 billion	$22.785 billion	1.7%
Gross profit	$3.456 billion	$3.415 billion	1.2%
Operating income	$652.7 million	$664.9 million	(1.8%)
Income from continuing operations attributable to PAG stockholders	$435.5 million	$470.5 million	(7.4%)
Net income attributable to PAG stockholders	$435.8 million	$471.0 million	(7.5%)
Diluted EPS	$5.28	$5.53	(4.5%)
Net cash from continuing operating activities	$518.3 million	$614.2 million	(15.6%)

Approximate consolidated gross margin was 14.9%, operating margin 2.8% and net margin attributable to PAG stockholders 1.9%.
Retail automotive revenue was $20.616 billion, down 1.1%. Retail commercial truck revenue was $2.051 billion, up 49.2%, primarily reflecting acquisitions. Commercial vehicle distribution and other revenue was $513.1 million, down 8.6%.
Retail automotive generated $3.0 billion of gross profit. Service and parts revenue increased 2.1% to $2.196 billion, while finance and insurance revenue increased 3.6% to $652.1 million.
New automotive retail unit sales declined 5.6% to 222,704, while used retail unit sales increased 0.6% to 284,190. Used-vehicle gross profit declined 10.5% to $366.1 million, driven by lower gross profit per unit.
Retail commercial truck revenue increased substantially following the acquisition of Warner Truck Centers. New truck unit sales increased 43.5% to 11,897, but same-store new truck gross profit declined 2.3%; used truck gross profit declined 27.6%.
Equity in earnings of affiliates increased 9.4% to $147.5 million, including $142.4 million from PTS. PAG received $71.9 million of cash distributions from PTS during 2019.
The effective tax rate increased to 26.5% from 22.2%, partly because 2018 included an $11.6 million tax benefit related to final Tax Cuts and Jobs Act adjustments.

Cash Flow, Debt and Liquidity

Continuing operating cash flow was $518.3 million; including non-trade floor-plan financing activity, management presented operating cash flow of $695.8 million.
Capital expenditures were $245.3 million, and cash used for acquisitions and other investments was $326.9 million. Continuing investing cash outflow was $532.7 million.
Cash and cash equivalents totaled $28.1 million at December 31, 2019, compared with $39.4 million at year-end 2018.
Floor-plan notes payable totaled $4.007 billion, including $2.413 billion of trade floor-plan debt and $1.594 billion of non-trade floor-plan debt. Total long-term debt was $2.360 billion.
Available borrowing capacity was $655.0 million under the U.S. credit agreement, £35.0 million under the U.K. credit agreement and AU$50.0 million under the Australian working-capital facility.
Total undiscounted operating lease commitments were $5.424 billion; recognized operating lease liabilities were $2.392 billion after adoption of ASC 842.
The company repurchased 3,986,836 shares for $174.1 million and paid $130.8 million in dividends. The remaining repurchase authorization was $200.0 million. The quarterly dividend increased throughout 2019, and a $0.42-per-share dividend was declared for payment in March 2020.
Management stated that operating cash flow, distributions from joint ventures and existing credit and floor-plan facilities should fund operations and current commitments for at least the next twelve months. The company was in compliance with its debt and lease covenants at year-end.

Material Changes Versus 2018

Revenue increased modestly, but operating income, continuing-operations income and EPS declined.
Foreign-currency movements reduced 2019 revenue by $475.3 million, gross profit by $67.0 million and continuing-operations EPS by approximately $0.07. Excluding currency effects, revenue and gross profit increased 3.8% and 3.2%, respectively.
New automotive sales weakened, particularly in the U.K., while used-vehicle gross profit contracted because of lower vehicle values and margins, especially for U.K. diesel-related inventory.
Finance and insurance and service and parts performance provided support despite lower vehicle volumes.
The Warner Truck Centers acquisition added six locations in Utah and Idaho and contributed to the significant increase in the retail commercial truck segment.
PAG disposed of 25 automotive franchises, representing approximately $540 million of annualized revenue, while opening two used-vehicle supercenters and increasing its ownership of the Jacobs Group to 91.8%.
Adoption of ASC 842 brought substantial operating lease assets and liabilities onto the balance sheet and increased retained earnings by approximately $5.0 million after tax.

Outlook, Risks and Unusual Items

Management expects U.S. new-vehicle demand to remain strong but plateaued, with trucks, crossovers and SUVs outperforming passenger cars. Class 8 heavy-duty truck sales were expected to decline approximately 20% to 30% in 2020 according to ACT Research.
Management expects PTS to benefit from demand for outsourced fleet, maintenance and logistics services, while expecting commercial vehicle distribution and engine repower activity to remain stable.
Key risks include economic and consumer-credit conditions, interest-rate increases, variable-rate debt, foreign-exchange volatility, Brexit, tariffs, vehicle supply disruptions, recalls, manufacturer franchise controls, changing emissions rules, electrification, digital competition and cybersecurity.
The U.K. generated approximately 33% of consolidated revenue in 2019. Brexit-related trade terms, border delays, currency movements and consumer uncertainty could materially affect U.K. results.
Approximately $4.0 billion of floor-plan debt, $2.4 billion of non-vehicle long-term debt and $5.4 billion of lease commitments create significant fixed and variable cash requirements. A 100-basis-point rate change was estimated to affect annual floor-plan interest expense by approximately $37.4 million and other interest expense by approximately $2.5 million.
The company recorded a $1.9 million impairment charge on certain franchise agreements in 2019. Goodwill was $1.911 billion and other indefinite-lived intangible assets were $552.2 million at year-end; impairment testing depends on forecasts, margins and discount rates.
No legal proceeding was identified as reasonably expected to have a material effect, although unfavorable outcomes remain possible. The company remained liable for approximately $214.3 million of lease payments associated with certain sold, closed or subleased properties.
Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting. Warner Truck Centers, acquired in July 2019, was excluded from management’s internal-control assessment and represented less than 2% of total assets and less than 3% of total revenue.

Investor Verification Checklist

Verify the sustainability of used-vehicle margins, particularly in the U.K., and the effect of diesel, residual-value and emissions trends.
Assess whether Warner Truck Centers and other acquisitions generate expected revenue, gross profit and cash returns after integration.
Review floor-plan debt, the 2020 maturity of the $300 million senior subordinated notes, covenant headroom and refinancing capacity.
Monitor variable interest-rate exposure, LIBOR replacement provisions and the effect of rates on vehicle affordability and inventory financing.
Evaluate the cash-flow impact of $5.4 billion of lease commitments, capital expenditures, dividends, repurchases and acquisition spending.
Track U.K. Brexit developments, foreign-exchange movements and their effect on reported revenue, earnings and liquidity.
Review PTS operating performance, distributions and restrictions on partner distributions, as well as the carrying value of PAG’s equity-method investments.
Reconcile annual results with the unaudited fourth-quarter data and investigate the effect of 2018 tax benefits and other non-recurring items on year-over-year comparisons.