Business context and reporting period
Group 1 Automotive, Inc. filed this Form 10-K for the fiscal year ended December 31, 2016. It operates franchised dealerships in the U.S., U.K. and Brazil, selling new and used vehicles and providing parts, service, collision repair, financing and insurance products. At year-end, it had 210 franchises, 159 dealership locations and 38 collision centers. The filing reports full-year results; selected fourth-quarter results are also shown below.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Revenue | $10.888 billion | $10.633 billion |
| Gross profit / margin | $1.595 billion / 14.7% | $1.534 billion / 14.4% |
| Operating income / margin | $340.2 million / 3.1% | $278.3 million / 2.6% |
| Net income | $147.1 million | $94.0 million |
| Diluted EPS | $6.67 | $3.90 |
| Operating cash flow (GAAP) | $384.9 million | $141.0 million |
| Adjusted operating cash flow (non-GAAP) | $271.7 million | $244.3 million |
Revenue rose 2.4% and gross profit rose 4.0%. Adjusted operating margin was 3.4%, unchanged from 2015; adjusted diluted EPS was $7.42 versus $6.87. These adjusted measures exclude specified items and are non-GAAP.
- Business mix: Parts and service generated 42.6% of gross profit; finance and insurance 26.4%; new vehicle retail 19.8%; used vehicle retail 11.2%. Parts and service revenue increased 6.3%; total retail vehicle units increased 0.8%, with new units down 1.5% and used units up 4.0%.
- Segments: U.S. revenue was $8.735 billion and net income $139.6 million; U.K. revenue was $1.723 billion and net income $14.4 million; Brazil revenue was $429.8 million and net loss $7.0 million. U.S. revenue declined, U.K. revenue grew substantially with acquisitions, and Brazil remained challenged.
- Fourth quarter: Revenue was $2.674 billion versus $2.673 billion in Q4 2015; gross profit was $389.2 million versus $380.1 million; net income was $30.8 million versus a $33.4 million net loss, with prior-year results burdened by impairment charges.
- Margins and costs: New vehicle gross margin improved to 5.2% from 5.1%; used vehicle gross margin declined to 5.6% from 5.8%; parts and service gross margin was 53.9% versus 54.1%. SG&A was 73.4% of gross profit versus 73.1%.
- Balance sheet and debt: Cash was $21.0 million, working capital $97.5 million, total assets $4.462 billion and stockholders’ equity $930.2 million. Long-term debt, including current maturities, was $1.269 billion; floorplan notes payable were about $1.444 billion net of disclosed offset accounts. The company reported $3.598 billion of contractual obligations, including floorplan debt, other debt, interest and lease obligations.
- Borrowing capacity and covenants: Available U.S. facility capacity was $841.0 million, including $322.9 million under the acquisition line. The revolving facility matures in June 2021. The company reported compliance with covenants: leverage ratio 3.70 against a maximum 5.50; fixed-charge coverage 2.49 against a minimum 1.20.
- Capital returns and investment: FY 2016 dividends were $0.91 per share ($20.0 million paid). The company repurchased 2.28 million shares for $127.6 million. Investing cash use was $174.0 million, including $57.3 million for acquisitions and $156.5 million for property and equipment, including real estate.
Material changes, outlook and risks
- U.S. same-store new vehicle units fell 7.0%, affected by weakness in energy-dependent Texas and Oklahoma markets; management cited depressed oil prices. Brazil industry registrations fell 19.8% in 2016, and Group 1’s Brazil net loss improved from $63.6 million in 2015.
- The company acquired 12 U.K. dealerships and one in Brazil, and opened additional locations; it also disposed of five U.S., four Brazil and one U.K. dealerships. Acquisitions and currency movements affect comparability.
- FY 2016 included $32.8 million of non-cash impairment charges, principally $30.0 million of franchise-right impairments. No goodwill impairment was recorded in 2016; 2015 included $55.4 million of Brazil goodwill impairment. A 200-basis-point increase in the assumed WACC would have produced an additional estimated $40.2 million of franchise-right impairment.
- A Volkswagen diesel-settlement gain of $11.7 million pretax was recognized in 2016. Group 1 expected to receive approximately $13.2 million related to its current and prior ownership of seven U.S. Volkswagen dealerships; half had been received by February 2017, with the balance payable in 18 monthly installments.
- Management’s stated 2017 priorities include growing higher-margin parts and service, improving vehicle retail profitability and customer satisfaction, and increasing operating efficiency. Forecast capital expenditures were no more than $150 million, excluding acquisitions. Management expected an effective tax rate of about 36.5%.
- Management expected U.K. industry sales could decline about 10% in 2017 following Brexit-related volatility; Brazil industry sales were expected to be about level with 2016. The filing does not provide a consolidated revenue or earnings forecast.
- Key risks include economic and credit conditions, vehicle pricing and inventory, dependence on manufacturers and franchise approvals, competition, interest-rate and foreign-exchange movements, Brazil’s recession, Brexit uncertainty, debt covenants, environmental and legal exposure, and cyber-security risks. A 100-basis-point interest-rate change was estimated to affect annual interest expense by about $10.2 million after swaps, based on 2016 average borrowings.
- GAAP operating cash flow benefited from working-capital movements, including a $79.3 million inventory decrease; the company’s adjusted non-GAAP operating cash flow was $271.7 million. Management stated available cash flow and borrowing capacity should fund 2017 operations, capital expenditures and acquisitions, subject to economic and plan changes.
Investor verification priorities
- Reconcile reported EPS growth with impairment charges, the Volkswagen settlement gain, tax-rate changes and the company’s non-GAAP adjustments.
- Assess whether higher parts and service revenue and improved new-vehicle pricing can offset lower U.S. and Brazil unit volumes, used-vehicle margin pressure and higher interest costs.
- Review debt maturities, floorplan financing, covenant headroom, interest-rate swaps and restrictions on dividends and share repurchases.
- Check the realization of the Volkswagen settlement installments and any related finance-and-insurance chargebacks.
- Monitor U.K. trading and currency effects after Brexit, Brazil’s recovery, and impairment sensitivity in franchise rights and goodwill.
- Evaluate acquisition returns, planned capital spending and cash generation after working-capital effects. The filing reports an unqualified audit opinion and effective internal controls as of December 31, 2016.