Group 1 Automotive, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless noted. The company operates dealerships in the U.S., U.K. and Brazil and reported those as three segments. At quarter-end it had 158 dealership locations and 209 franchises.
Financial and operating performance
| Metric | Q1 2017 | Q1 2016 | Change / context |
|---|---|---|---|
| Revenue | $2,518.8 million | $2,608.4 million | Down 3.4% |
| Gross profit | $383.5 million | $389.1 million | Down 1.4%; gross margin rose to 15.2% from 14.9% |
| Operating income | $80.1 million | $82.0 million | Operating margin 3.2%, versus 3.1% |
| Income before tax | $51.2 million | $54.1 million | Down 5.4% |
| Net income | $33.9 million | $34.3 million | Down 1.0% |
| Diluted EPS | $1.58 | $1.47 | Up 7.5%, helped by a 7.8% decrease in diluted weighted-average shares |
| Cash from operating activities (GAAP) | $71.6 million | $116.1 million | Down 38.3%; management’s adjusted, non-GAAP measure was $106.4 million versus $98.6 million |
- Revenue mix: New vehicle retail sales were $1,337.2 million, used retail $660.9 million, wholesale $104.2 million, parts and service $319.7 million, and finance, insurance and other $96.8 million.
- Margins and sales: New vehicle retail gross margin increased to 5.2% from 5.1%; total used vehicle margin declined to 5.9% from 6.4%; parts and service margin was 53.9% versus 54.0%. Retail unit sales fell 5.1% to 69,856. SG&A was 75.6% of gross profit, compared with 75.5%; adjusted SG&A as a share of gross profit rose to 76.0% from 74.8%.
- Segment results: U.S. revenue was $1,967.7 million and pretax income $45.6 million; U.K. revenue was $450.3 million and pretax income $5.4 million; Brazil revenue was $100.8 million and pretax income $0.2 million. U.S. revenue declined 5.5%; U.K. and Brazil revenue increased 4.3% and 6.3%, respectively, with foreign exchange affecting reported comparisons.
- Cash, liquidity and capital spending: Cash was $33.8 million at March 31, up from $21.0 million at year-end. Working capital was $131.8 million. Investing activities used $41.9 million, including $46.5 million of property and equipment purchases and real estate spending. Management expected 2017 capital expenditures below $130 million.
- Debt and borrowing capacity: Long-term debt, including current maturities, totaled $1,263.6 million. Vehicle floorplan financing is a substantial additional funding obligation. The company reported $841.7 million of available capacity under its U.S. revolving and Ford credit facilities, subject to borrowing-base and covenant limits. It reported compliance with covenants: leverage ratio 3.70 against a maximum of 5.50; fixed-charge coverage 2.46 against a minimum of 1.20.
- Interest exposure: Variable-rate borrowings were $1,583.7 million. The filing estimates that a 100-basis-point rate increase would add about $7.6 million to annual interest expense after the effect of swaps. The company had $819.3 million of swaps in effect and $625.0 million of forward-starting swaps.
Material changes and unusual items
- U.S. new vehicle retail unit sales fell 10.7%; management attributed relative weakness to soft energy-dependent markets, particularly Texas and Oklahoma. U.S. industry registrations declined 1.4%.
- Parts and service revenue increased 3.6%, supported in part by recall work and operational initiatives. Used vehicle retail gross profit declined 8.5%, while used wholesale gross profit fell to $0.1 million from $1.4 million, including weak U.S. wholesale results.
- Reported Q1 2017 results included a $1.8 million pretax gain from an OEM legal settlement ($1.1 million after tax). Adjusted net income was $32.8 million and adjusted diluted EPS $1.53. Q1 2016 adjusted net income was $37.1 million and adjusted diluted EPS $1.59; these non-GAAP comparisons exclude specified unusual items.
- The company received installments under a previously accepted Volkswagen settlement relating to seven U.S. dealerships; it had received half of the approximately $13.2 million total by January 2017 and two of the remaining 18 monthly installments by March 31. A separate settlement concerning three Audi dealerships was recognized in Q1 2017.
- The company opened one U.K. dealership, added motorcycles at a Brazil dealership, and disposed of two Brazil dealerships. There were no common-stock repurchases in Q1; dividends were $0.24 per share, versus $0.22 in Q1 2016.
Outlook, commentary and risks
- Management cited U.S. headwinds in energy-dependent markets and focused on improving vehicle gross profit per unit, growing higher-margin parts and service, operating efficiencies, and disciplined investment. It expected consolidated operations to continue generating positive cash flow and believed available cash and borrowing capacity would fund operations, capital spending and acquisitions for the remainder of 2017, subject to business conditions.
- Management expected the U.K. market to remain volatile and potentially decline in 2017 following Brexit; sterling weakness may affect reported results and vehicle affordability. Brazil remained in recession, and management expected 2017 industry sales to be about level with 2016.
- Management expected an effective tax rate of approximately 36% for the remainder of 2017. The filing provides no specific full-year revenue or earnings guidance.
- Key risks include consumer demand and credit availability, manufacturer incentives and vehicle supply, interest-rate increases, foreign exchange movements, economic weakness in Brazil and the U.K., manufacturer concentration, recalls, litigation, and the company’s ability to manage costs and inventory. The company does not hedge its foreign currency exposure.
- Adoption of the new lease accounting standard was expected to significantly increase balance-sheet assets and liabilities because approximately half of the company’s real estate was rented under operating leases. The company had not yet quantified the effect of the revenue-recognition standard.
- The filing reported no legal proceeding expected to have a material adverse effect, while noting that outcomes of current or future matters cannot be predicted with certainty. Management stated disclosure controls were effective at the reasonable-assurance level.
Important facts for investors to verify
- Whether underlying earnings and margins are improving after removing the OEM settlement and other non-GAAP adjustments.
- Whether weak U.S. vehicle volumes, used-vehicle profitability and wholesale margins stabilize, and whether parts and service growth persists.
- How floorplan financing, variable rates, swap coverage and covenant headroom affect interest costs and financial flexibility.
- Whether cash-flow comparisons are assessed using GAAP figures or management’s adjusted classification of floorplan cash flows.
- The effects of sterling and Brazilian real movements, Brexit uncertainty, and continued economic weakness in Brazil on segment performance.
- The eventual balance-sheet impact of lease accounting adoption and any material developments in settlements, litigation or manufacturer-related contingencies.