Group 1 Automotive, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. The company operates franchised dealerships, collision centers, parts and service, and vehicle financing and insurance businesses in the U.S., U.K. and Brazil. At quarter-end it reported 159 dealership locations, 210 franchises and 45 collision centers. Figures below are in U.S. dollars; financial statements are unaudited.
Financial performance
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Revenue | $2.672bn | $2.782bn | $5.191bn | $5.391bn |
| Gross profit | $404.9m | $410.1m | $788.4m | $799.2m |
| Income from operations | $92.2m | $97.4m | $172.4m | $179.4m |
| Net income | $39.1m | $46.6m | $73.1m | $80.9m |
| Diluted EPS | $1.84 | $2.12 | $3.42 | $3.57 |
| Gross margin | 15.2% | 14.7% | 15.2% | 14.8% |
| Operating margin | 3.5% | 3.5% | 3.3% | 3.3% |
| Pretax margin | 2.3% | 2.5% | 2.2% | 2.3% |
| SG&A as % of gross profit | 73.7% | 72.9% | 74.6% | 74.2% |
Q2 total vehicle retail sales were 72,879 units, down from 76,595; new retail units fell 6.3% and used retail units fell 2.9%. Parts and service revenue rose 3.0% to $331.6m. Finance, insurance and other revenue declined 1.0% to $106.5m, while finance and insurance revenue per retail unit increased 4.1% to $1,461. Q2 cash dividends were $0.24 per share.
Cash flow, balance sheet and debt
- Six-month GAAP operating cash flow was $54.7m, compared with $172.9m in 2016. The company’s non-GAAP adjusted operating cash flow, which reclassifies certain floorplan financing cash flows, was $127.4m versus $152.1m.
- Six-month investing cash outflow was $119.8m, including $67.3m for property, equipment and real estate and $57.1m in deposits for real estate and dealership acquisitions. Financing cash inflow was $70.6m; cash increased $5.6m to $26.6m.
- Inventory rose $152.1m from year-end to $1.804bn, including a $123.0m increase in new vehicles. Management attributed the new-vehicle build partly to softer Houston sales. New-vehicle supply was 75 days, up from 62 days at year-end; used-vehicle supply was 33 days, down from 35.
- Working capital was $167.0m. The company reported $292.9m available on its U.S. floorplan line and $298.8m available on its acquisition line, subject to borrowing-base and covenant conditions. It also had $135.9m available under the $300m Ford floorplan facility.
- Long-term debt, net of current maturities, was $1.264bn; current maturities and short-term financing were $53.2m. Senior notes had $550m principal at 5.00% due 2022 and $300m at 5.25% due 2023. Separately, floorplan notes payable were substantial: $1.214bn under credit facilities and other, and $430.6m with manufacturer affiliates, before offset accounts.
- The company was in compliance with credit-facility covenants. Its total adjusted leverage ratio was 3.82 against a maximum of 5.50, and its fixed-charge coverage ratio was 2.41 against a minimum of 1.20.
Changes versus prior comparable period
- Q2 revenue fell 4.0%, gross profit fell 1.3%, net income fell 16.0% and diluted EPS fell 13.2%. First-half revenue declined 3.7%, net income 9.6% and diluted EPS 4.2%.
- U.S. softness, particularly in energy-dependent Texas and Oklahoma markets, weighed on new and used vehicle sales. U.S. new-vehicle retail units declined 7.2% in Q2; used retail units declined 6.2%.
- Higher-margin parts and service helped support gross margin: consolidated gross margin expanded 50 basis points in Q2 and 40 basis points in the first half. However, lower vehicle gross profit and SG&A leverage pressured earnings.
- U.K. revenue reported in dollars was affected by the weaker pound. On a constant-currency basis, Q2 U.K. revenue rose 4.7%; management also cited U.K. industry volatility and a shift in demand toward used vehicles following an April road-tax change.
- Brazil revenue increased 3.8% in Q2, but the business remained challenged; management described prioritizing vehicle margins over unit volume. Brazil’s first-half new-vehicle registrations increased 4.3% industry-wide.
- Floorplan interest expense rose 14.1% in Q2 and 11.3% in the first half, primarily reflecting higher LIBOR, partly offset by lower average U.S. borrowings. Depreciation and amortization increased 10.9% in Q2.
Outlook, risks and unusual items
- Management expected 2017 capital spending below $120m, excluding real estate purchases tied to franchise acquisitions and lease buyouts. It expected a 2017 effective tax rate of 35%–36% and stated it expected adequate cash flow and borrowing capacity to fund operations, capital spending and acquisitions for the remainder of the year.
- No full-year revenue or EPS guidance was provided. Management cited declining U.S. industry registrations in the first half, continued softness in energy-dependent U.S. markets, expected U.K. industry volatility and potentially lower U.K. industry sales for full-year 2017, and challenging near-term Brazilian conditions.
- Management’s priorities included improving vehicle gross profit per unit, growing parts and service, improving operating efficiency, disciplined capital investment and pursuing dealership acquisitions. It also said capital allocation among acquisitions, repurchases and dividends would depend on market conditions.
- Reported first-half results included a $1.8m pretax OEM legal-settlement gain, $0.6m of catastrophic-event losses and $0.3m of acquisition costs. Q2 included $0.6m of catastrophic-event losses and $0.3m of acquisition costs. These are among items excluded in management’s non-GAAP adjusted measures.
- Volkswagen settlement compensation related to seven U.S. dealerships totaled approximately $13.2m; half was received in January 2017, with remaining installments payable over 18 months. The company also received and recognized a separate Audi-related settlement in Q2. Management said no pending legal matter was then reasonably expected to have a material adverse effect, but outcomes remain uncertain.
- Key risks include vehicle demand and consumer credit, manufacturer incentives and franchise relationships, inventory supply and valuation, interest rates, foreign exchange movements, competition, regulation, catastrophic events, and the company’s ability to refinance or obtain financing. The company did not hedge foreign-currency exposure. It estimated that a 10% weakening of the pound or Brazilian real would have reduced first-half revenue by $80.7m or $19.3m, respectively.
- The company expected lease-accounting changes to significantly affect its balance sheet because approximately half of its real estate is rented. It did not expect the upcoming revenue-recognition standard to have a material financial-statement impact, but had not quantified any effects.
Important facts for investors to verify
- Whether vehicle volumes and gross profit per unit stabilize, especially in Texas and Oklahoma, and whether the higher new-vehicle inventory and 75-day supply are reduced without further margin pressure.
- Whether parts-and-service growth is sustainable and can offset vehicle-sales weakness and rising SG&A as a percentage of gross profit.
- How much operating cash flow depends on floorplan financing classifications and inventory movements; compare GAAP cash flow with the company’s clearly labeled non-GAAP adjusted measure.
- Debt, borrowing availability and covenant headroom, including the distinction between long-term debt and floorplan financing, and sensitivity to higher rates. A 100-basis-point rate increase was estimated to raise annual interest expense by about $8.0m after swaps.
- Execution against the capital-spending and tax-rate outlook, progress on acquisitions and the effect of share repurchases, dividends and restricted-payment limits.
- Foreign-exchange exposure, U.K. and Brazil operating trends, settlement collections, legal contingencies and the eventual balance-sheet effect of lease-accounting adoption.