Group 1 Automotive, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; unaudited results. Group 1 operates franchised dealerships in the U.S., U.K. and Brazil, selling new and used vehicles and providing finance, insurance, parts and service offerings.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $3.012 billion (+6.7%) | $2.823 billion | $8.203 billion (-0.1%) | $8.214 billion |
| Gross profit | $431.4 million (+6.1%) | $406.7 million | $1.220 billion (+1.2%) | $1.206 billion |
| Income from operations | $78.5 million (-6.4%) | $83.9 million | $250.9 million (-4.7%) | $263.3 million |
| Net income | $29.9 million (-15.5%) | $35.4 million | $103.0 million (-11.4%) | $116.2 million |
| Diluted EPS | $1.43 (-13.3%) | $1.65 | $4.85 (-7.1%) | $5.22 |
| Gross margin | 14.3% | 14.4% | 14.9% | 14.7% |
| Operating margin | 2.6% | 3.0% | 3.1% | 3.2% |
Management’s non-GAAP adjusted results exclude specified items and should be considered alongside GAAP results: Q3 adjusted net income was $46.6 million and adjusted diluted EPS was $2.23, up 11.1% and 13.8%, respectively. For the nine months, adjusted net income was $119.2 million and adjusted diluted EPS was $5.62, down 5.7% and 1.1%, respectively.
- Revenue mix and operating trends: Q3 revenue increased in the U.K. (35.5%, including acquisitions), Brazil (6.3%) and U.S. (1.2%). U.K. same-store revenue grew 8.8%. Nine-month revenue growth in the U.K. and Brazil was offset by a 2.6% U.S. decline. Parts and service revenue rose 7.4% in Q3 and 4.6% year to date.
- Cash flow: Nine-month GAAP operating cash flow was $309.9 million, down from $386.6 million; investing cash outflow was $246.7 million, versus $157.0 million; financing cash outflow was $18.1 million, versus $222.1 million. Cash increased by $45.9 million to $66.9 million. Management’s adjusted operating cash flow, a non-GAAP measure, was $231.6 million versus $237.8 million.
- Liquidity and debt: Working capital was $96.4 million. The company reported $1.293 billion of long-term debt, net of current maturities, and $81.0 million of current maturities and short-term financing. Floorplan notes payable were $1.477 billion before $68.2 million of related offset accounts. Available capacity was $422.8 million on the floorplan line and $297.1 million on the acquisition line; the latter is subject to borrowing-base and covenant limits. The company was compliant with credit-facility covenants: leverage ratio 3.72 against a maximum of 5.50, and fixed-charge coverage 2.43 against a minimum of 1.20.
- Capital allocation: Nine-month capital spending was forecast below $120 million for full-year 2017, excluding real estate purchases tied to acquisitions and lease buy-outs. The company paid $15.2 million in dividends and repurchased $40.1 million of common stock during the first nine months.
Changes, outlook and key commentary
- Q3 revenue growth did not translate into higher GAAP earnings: SG&A increased 9.8%, floorplan interest expense increased 21.2%, and operating income and net income declined. GAAP SG&A was 76.1% of gross profit versus 73.5% a year earlier; adjusted SG&A was 72.8% versus 73.6%.
- Hurricane Harvey caused business disruption and property and inventory losses, with $8.1 million of Q3 SG&A charges and a $6.6 million reserve for expected finance-and-insurance contract cancellations. The storm also drove replacement-vehicle sales in Houston and Beaumont; management expected near-term vehicle sales and aftersales activity to benefit from recovery. Total Q3 catastrophic-event losses were reported at $14.7 million pretax.
- A $9.5 million non-cash impairment charge related to franchise rights at one U.S. dealership was recorded in Q3. Management reported no goodwill impairment indicators. Adjusted results exclude impairment and other items; the company cautions that such non-GAAP measures are not GAAP substitutes.
- Management cited declining U.S. and U.K. industry new-vehicle registrations for the first nine months (1.9% and 3.9%, respectively), continuing weakness in U.S. energy-dependent markets, U.K. market volatility and currency exposure following Brexit, and challenging Brazilian economic conditions. Brazil industry registrations rose 7.9% over the period.
- Management’s priorities include improving vehicle gross profit per unit, growing higher-margin parts and service, controlling costs, and pursuing acquisitions. It expected full-year 2017 effective tax rate of 35%–36% and believed operating cash flow and available borrowing capacity would support operations, capital spending and acquisitions through year-end.
- Interest-rate exposure remains material: $1.588 billion of variable-rate borrowings were outstanding. Management estimated that a 100-basis-point rate move, after swaps, would change annual interest expense by approximately $8.1 million. The company does not hedge foreign-currency exposure; a 10% currency devaluation would have reduced nine-month reported revenue by an estimated $134.4 million for sterling and $30.2 million for the Brazilian real.
- The filing said no current legal proceeding was reasonably expected to have a material adverse effect, while noting outcomes of future matters cannot be predicted. Volkswagen-related settlements included approximately $13.2 million for seven U.S. dealerships, with remaining installments payable, and a separate Audi settlement received in Q2 2017.
Important facts for investors to verify
- Whether post-Harvey replacement demand and service activity persisted, and the ultimate effect of storm-related losses and finance-and-insurance chargebacks.
- Underlying same-store performance and the reconciliation of management’s adjusted earnings and cash-flow measures to GAAP results.
- Debt, floorplan availability, covenant headroom and sensitivity to higher interest rates, including the effect and coverage of interest-rate swaps.
- U.K. and Brazil operating trends, foreign-exchange movements, and the contribution and integration costs of recent acquisitions.
- Execution against the 2017 capital-spending outlook and the balance among acquisitions, dividends and share repurchases under restricted-payment limits.