PENSKE AUTOMOTIVE GROUP, INC. quarterly report, Q3 FY2015

Penske Automotive Group, Inc. — 2015 Q3 Form 10-Q

Reporting period: Three and nine months ended September 30, 2015, compared with the corresponding 2014 periods. The interim financial statements are unaudited.

Business context

Penske Automotive Group operates automotive and commercial truck dealerships principally in the United States and Western Europe and distributes commercial vehicles, engines, power systems, parts and services principally in Australia and New Zealand. As of September 30, 2015, it operated 352 automotive retail franchises and employed more than 22,000 people worldwide.

Retail Automotive represented 92.8% of nine-month revenue and 90.9% of gross profit.
Retail Commercial Truck included Premier Truck Group, in which ownership increased to 96% during the third quarter.
A German automotive dealership joint venture became consolidated after PAG increased its ownership to 60%.
Retail Commercial Truck and Penske Power Systems were significant additions relative to the 2014 comparable periods.

Financial performance and metrics

Metric	Q3 2015	Q3 2014	9M 2015	9M 2014
Total revenue	$4,960.1 million	$4,396.7 million	$14,363.6 million	$12,806.4 million
Gross profit	$729.2 million	$647.6 million	$2,150.4 million	$1,919.1 million
Operating income	$146.0 million	$128.0 million	$440.4 million	$382.5 million
Income from continuing operations	$87.6 million	$77.3 million	$260.2 million	$224.1 million
Net income attributable to PAG common stockholders	$86.6 million	$74.5 million	$255.8 million	$214.9 million
Diluted EPS	$0.96	$0.83	$2.84	$2.38

Revenue increased 12.8% in Q3 and 12.2% for nine months; gross profit increased 12.6% and 12.1%, respectively.
Approximate gross margins were 14.7% in Q3 and 15.0% for nine months. Operating margins were 2.9% and 3.1%, respectively. Net margins attributable to PAG common stockholders were 1.7% in Q3 and 1.8% for nine months.
Q3 revenue included $4,585.8 million from Retail Automotive, $268.5 million from Retail Commercial Truck and $105.8 million from Commercial Vehicle Distribution and Other.
For nine months, retail automotive new vehicle units increased 6.6% and used vehicle units increased 7.8%; same-store new and used units increased 5.3% and 6.1%, respectively.
Used vehicle gross profit per unit declined 8.9% for nine months, and used vehicle gross margin declined to 6.3% from 7.0%.
Service and parts revenue increased 5.7% for nine months, while finance and insurance revenue increased 7.6%.
Foreign currency translation reduced nine-month revenue by $579.6 million and gross profit by $84.9 million; management estimated a $0.14 reduction in continuing-operations EPS.

Cash flow, balance sheet, debt and liquidity

Cash provided by continuing operating activities was $373.4 million for the first nine months, compared with $276.0 million in 2014. Including non-trade floor plan borrowings as operating cash flow, the comparable 2015 figure was $468.0 million.
Cash used in continuing investing activities was $236.3 million, including $151.1 million of capital expenditures and $85.4 million of acquisition spending.
Cash used in continuing financing activities was $163.1 million, including $165.7 million of net long-term debt repayments, $62.3 million of dividends and $22.0 million of share repurchases.
Cash and cash equivalents were $49.7 million at September 30, 2015, versus $36.3 million at December 31, 2014. Working capital was $90.6 million.
Total long-term debt was $1,184.9 million, including $850.0 million of senior subordinated notes, $167.8 million of mortgage facilities and $78.0 million drawn on the U.S. revolving credit line.
Floor plan notes payable totaled $3,168.6 million, comprising $2,096.0 million of trade floor plan debt and $1,072.6 million of non-trade floor plan debt.
Available borrowing capacity was $602.0 million under the U.S. credit agreement, £128.8 million under the U.K. credit agreement and AU$28.0 million under the Australian working capital facility.
Management stated that existing operating cash flow, distributions and credit and floor plan facilities should fund current operations and commitments for at least the next twelve months. The company was in compliance with its debt and lease covenants at September 30, 2015.

Material changes versus the prior comparable period

Growth reflected same-store increases and the acquisitions of Premier Truck Group and Penske Power Systems, as well as the consolidation of the German joint venture.
SG&A increased 11.2% for nine months, but declined from 77.4% to 76.8% of gross profit.
Other interest expense increased 31.7% for nine months to $49.0 million, primarily due to the $300.0 million of 5.375% senior subordinated notes issued in November 2014 and acquisition-related borrowing.
Floor plan interest expense decreased 4.4% for nine months to $32.7 million, mainly because interest-rate swaps expired in December 2014.
Long-term debt declined from $1,353.2 million at December 31, 2014 to $1,184.9 million at September 30, 2015, while floor plan debt increased with inventory levels.
Discontinued operations produced a $1.1 million loss for nine months versus a $7.2 million loss in 2014. PAG divested its car rental business and two San Francisco automotive franchises.
Other comprehensive loss was $59.3 million for nine months, primarily from a $57.0 million foreign currency translation loss.

Guidance, outlook, risks and unusual items

Management expected U.S. and U.K. new-vehicle markets to remain strong through the remainder of 2015 and expected continued strength in North American Class 5–8 truck markets.
Management expected Australian commercial vehicle markets to lag historical levels because of weaker commodity prices, macroeconomic conditions and a weaker Australian dollar, while parts distribution was expected to remain more resilient.
Key risks include economic cycles, consumer demand, interest rates, foreign exchange, credit availability, manufacturer and franchise dependence, vehicle recalls, inventory availability, acquisition integration, covenant compliance, liquidity and access to floor plan financing.
A 100-basis-point interest-rate change was estimated to affect annual other interest expense by approximately $1.3 million and annual floor plan interest expense by approximately $27.4 million.
A 10% change in average foreign exchange rates against the U.S. dollar would have changed nine-month revenue by approximately $559.4 million.
PAG disclosed exposure to litigation, lease guarantees, $23.8 million of letters of credit, $16.5 million of surety bonds and a contingent indemnity related to its 9% investment in Penske Truck Leasing.
The filing noted the September 2015 Volkswagen emissions matter. Volkswagen represented less than 3% of PAG’s global sales by revenue, but a widespread impact could adversely affect the business.
There were no legal proceedings that management expected to have a material adverse effect, although outcomes could not be predicted with certainty.

Important facts for investors to verify

Whether revenue and earnings growth remains strong after separating same-store performance from acquisitions and consolidation effects.
Whether used-vehicle gross profit per unit and margins stabilize or continue to decline.
The effect of foreign currency movements, particularly the British pound and Australian dollar, on reported results and equity.
Floor plan debt, inventory levels and sensitivity to higher variable interest rates.
Compliance with credit agreement, lease and other financial covenants and continued availability of borrowing facilities.
Integration and performance of Premier Truck Group, Penske Power Systems and the newly consolidated German joint venture.
Potential financial or reputational effects from manufacturer recalls, including Volkswagen-related regulatory matters.
Future acquisitions, capital expenditures, dividends and share repurchases relative to available cash flow and debt capacity.