PENSKE AUTOMOTIVE GROUP, INC. annual report, FY2015

Penske Automotive Group, Inc. — FY2015 Form 10-K Summary

Business context and reporting period

The filing covers the fiscal year ended December 31, 2015; the source is an annual Form 10-K rather than a standalone fourth-quarter filing. Penske Automotive Group operates automotive and commercial truck dealerships primarily in the United States and Western Europe and distributes commercial vehicles, engines, power systems, parts, and related services in Australia and New Zealand. The company employed more than 22,000 people and operated 355 automotive franchises at year-end.

Retail automotive dealerships generated 92.8% of total revenue and 91.0% of total gross profit.
Geographic revenue mix was approximately 61% United States and Puerto Rico, 34% United Kingdom, 3% Germany and Italy, and 2% Australia, New Zealand, and the Pacific.
The company retailed or wholesaled more than 523,000 vehicles and represented more than 40 brands, with 72% of automotive dealership revenue from premium brands.

Financial performance and key metrics

Metric	2015	2014	Change
Total revenue	$19.285 billion	$17.232 billion	+11.9%
Gross profit	$2.868 billion	$2.579 billion	+11.2%
Operating income	$566.5 million	$500.4 million	+13.2%
Income from continuing operations attributable to PAG stockholders	$329.6 million	$301.4 million	+9.4%
Net income attributable to PAG stockholders	$326.1 million	$286.7 million	+13.7%
Diluted EPS from continuing operations	$3.67	$3.34	+9.9%
Diluted EPS	$3.63	$3.17	+14.5%
Cash flow from continuing operations	$391.5 million	$359.3 million	+9.0%
Capital expenditures	$199.5 million	$176.1 million	+13.3%

Gross margin was approximately 14.9% in 2015 versus 15.0% in 2014. Operating margin improved to approximately 2.9% from 2.9% on rounded figures. Net income included a $3.5 million after-tax loss from discontinued operations.

Retail automotive revenue was $17.896 billion, up from $16.658 billion. New retail unit sales increased 7.8% to 233,524, while used retail unit sales increased 9.0% to 198,459.
New vehicle gross margin declined to 7.7% from 7.8%; average gross profit per new vehicle declined 2.8% to $3,027.
Used vehicle gross margin declined to 6.1% from 6.7%; average gross profit per used vehicle declined 10.2% to $1,654.
Finance and insurance revenue increased 9.7% to $478.3 million, and service and parts revenue increased 6.6% to $1.831 billion, with a 59.2% margin.
Premier Truck Group generated $944.1 million of revenue and $147.0 million of gross profit from 6,977 new and used truck sales and related service and parts operations.
Commercial vehicle distribution and other revenue was $444.5 million. Penske Commercial Vehicles Australia generated $233.6 million of revenue, while Penske Power Systems generated $197.9 million.
Equity in earnings of affiliates was $39.3 million, including $32.2 million attributable to the 9% investment in Penske Truck Leasing.

Liquidity, debt, and capital allocation

Cash and cash equivalents were $62.4 million at December 31, 2015, compared with $36.3 million at year-end 2014; reported working capital was $121.2 million.
Available borrowing capacity was $540.0 million under the U.S. credit agreement, approximately $165.0 million under the U.K. agreement, and approximately $14.9 million under the Australian working capital agreement.
Floor plan notes payable totaled $3.380 billion, up from $2.746 billion, reflecting higher inventory financing.
Total debt excluding floor plan notes payable was $1.284 billion, down from $1.353 billion. Debt included $550.0 million of 5.75% notes due 2022 and $300.0 million of 5.375% notes due 2024.
The company amended its U.S. credit agreement, increasing revolving capacity from $450.0 million to $700.0 million and extending the maturity to September 2018. It reported $160.0 million outstanding at year-end.
Operating lease commitments totaled approximately $5.060 billion, including reasonably assured extension periods. The company also remained liable for approximately $248.2 million of lease payments related to certain sold, closed, or subleased properties.
Cash provided by continuing operations was $391.5 million; cash used in investing activities was $351.7 million, including $156.9 million for acquisitions and $199.5 million for capital expenditures.
The company paid $84.8 million in dividends and repurchased $48.9 million of common stock in 2015. The quarterly dividend increased from $0.21 in the fourth quarter of 2014 to $0.25 in the fourth quarter of 2015, and a $0.26 dividend was declared for March 2016.

Material changes versus the prior comparable period

Revenue and gross profit increased primarily from same-store growth, the full-year contribution from Premier Truck Group and Penske Power Systems, and acquisitions. Excluding foreign currency effects, revenue increased 16.0% and gross profit increased 15.2%.
The strengthening U.S. dollar materially reduced reported results: foreign currency translation reduced revenue by $703.8 million, gross profit by $103.4 million, and continuing-operations EPS by approximately $0.14.
The company acquired two additional commercial truck dealerships, acquired or was awarded six automotive franchises in the U.S., and acquired an additional 10% interest in its German Jacobs joint venture, bringing ownership to 60% and adding 27 consolidated dealerships from September 2015.
The company increased its ownership of Premier Truck Group by 5% to 96% and acquired the Knoxville and Chattanooga truck dealerships.
The company divested its car rental business and six automotive franchises, including Nissan and Infiniti of San Francisco. These operations remained classified in discontinued operations under applicable accounting rules.
Used vehicle profitability weakened despite higher volume, while higher-margin finance and insurance and service and parts operations continued to grow.
Other interest expense rose 31.4% to $69.4 million, principally because of higher borrowings associated with the 2014 notes issuance and acquisitions. Floor plan interest expense decreased 4.3% to $44.5 million.
Comprehensive income attributable to PAG stockholders increased to $256.9 million, but accumulated other comprehensive loss increased to $122.5 million, primarily because of foreign currency translation.

Guidance, outlook, management commentary, risks, and unusual items

Management expected another strong year in U.S. and U.K. automotive markets, supported by economic conditions, consumer confidence, low unemployment, low interest rates, product introductions, vehicle age, and credit availability. Management expected the U.K. market to remain strong in 2016.

Management expected continued strength in North American Class 5-8 truck markets based on economic conditions and the order backlog, although industry reports indicated that the Class 8 market could decline year over year. Australian and New Zealand commercial vehicle markets were expected to remain pressured by weaker currencies, commodity prices, and broader macroeconomic conditions; parts distribution was viewed as more resilient.

Key exposures include economic cycles, consumer credit, interest rates, fuel prices, unemployment, vehicle demand, and used-car pricing.
Manufacturers control franchise terms and may terminate, not renew, or restrict franchise agreements; European operations generally lack U.S.-style franchise-law protections.
Brand concentration is material: BMW/MINI represented 27% of automotive dealership revenue, Audi/Volkswagen/Porsche/Bentley 22%, Toyota/Lexus/Scion 15%, and Mercedes-Benz/Sprinter/smart 10%.
Variable-rate debt and floor plan financing create significant interest-rate sensitivity. A 100-basis-point change was estimated to affect annual floor plan interest expense by approximately $30.1 million and other interest expense by approximately $2.3 million.
A 10% change in average foreign exchange rates versus the U.S. dollar would have changed 2015 revenue by approximately $747.8 million.
Risks include recalls, manufacturer supply disruptions, Volkswagen emissions-related matters, CFPB and U.K. Financial Conduct Authority scrutiny of dealer finance and insurance compensation, cybersecurity incidents, environmental liabilities, litigation, insurance gaps, and covenant compliance.
The company reported no material legal proceedings and no material environmental liabilities, but noted that outcomes and future remediation costs cannot be predicted with certainty.
Auditors issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management excluded the newly acquired Jacobs business from its internal-control assessment; Jacobs represented approximately 2% of consolidated assets and 1% of revenue.

Important facts for investors to verify

Reconcile reported growth with acquisition contributions and the substantial adverse foreign-currency impact.
Assess whether declining new- and used-vehicle gross profit per unit and margins are offset by service, parts, and finance and insurance growth.
Review leverage, floor plan dependence, variable-rate exposure, debt maturities, covenant requirements, and $5.060 billion of lease commitments.
Evaluate the sustainability of dividends and repurchases against operating cash flow, acquisitions, capital expenditures, and debt obligations.
Monitor U.S., U.K., and Australian market conditions, truck-market trends, commodity prices, exchange rates, and manufacturer order and supply conditions.
Review franchise concentration, manufacturer renewal and termination rights, recall exposure, finance-regulation developments, cybersecurity controls, and contingent obligations related to Penske Truck Leasing and subleased properties.