Asbury Automotive Group, Inc. (ABG) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to Asbury Automotive Group's Investor Update Call. Today's call is being recorded and will be available for replay later today. The press release announcing Asbury's proposed acquisition of Park Place Dealerships was issued yesterday evening and is posted on our website at asburyauto.com. Participating with us today are David Hult, President and Chief Executive Officer; and Patrick Guido, Senior Vice President and Chief Financial Officer. At the conclusion of the company's remarks, we will open the call for questions. Before we begin, the company would like to remind you that the discussion during the call today is likely to contain forward-looking statements. Forward-looking statements are statements other than those which are historical in nature. All forward-looking statements are subject to significant uncertainties, and actual results may differ materially from those suggested by the statements. For information regarding certain of the risks that may cause actual results to differ, please see the company's filings with the SEC from time to time, including their Form 10-K for the year ended December 2019 and any subsequently filed quarterly reports on Form 10-Q. The company expressly disclaims any responsibility to update forward-looking statements. In addition, certain non-GAAP financial measures as defined under SEC rules may be discussed on this call. As required by applicable SEC rules, they provide reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures on our website. I will now hand the call over to David Hult. Mr. Hult?

Good morning, everyone. Asbury's vision is to be the most guest-centric automotive retailer. Last night, we announced that we renegotiated the transformational acquisition of Park Place. We entered into an agreement to acquire 8 of the Park Place Dealerships, 2 collision centers and 1 auto auction, all of which are in the Dallas/Fort Worth market. This acquisition does not include the Jaguar/Land Rover open point in Austin or the ultra-high end premier collection. Before I discuss the Park Place acquisition, I'd like to give you an update on our business. We were significantly impacted by the COVID-19 pandemic beginning in the second half of March. As we saw business decline, we acted decisively to fortify our business to prepare for the inevitable slowdown. Unfortunately, this included terminating the original Park Place acquisition, furloughing employees and reducing salaries and benefits. We also acted quickly to rightsize our business, reduce expenses, defer most capital expenditures and negotiate significant discounts with certain vendors. We were able to cut monthly expenses by approximately $15 million. These actions, along with our omnichannel initiatives that we started 4 years ago, helped us achieve year-over-year monthly increases in pretax profit in May and June. I would like to call out one number specifically. For the first time, 20% of our used vehicle sales were transacted online through our PUSHSTART application. We have seen our new and used volumes sequentially improve each week with significantly higher profit per vehicle. Our June new unit sales were down 16% versus prior year. Part of the decline was a strategic decision to preserve inventory because of our low day supply. This also gave us the ability to increase new car margins. Our used unit sales were up over prior year. Our parts and service business recovered in June as the economy gradually opened up. We ended up flat against prior year. In March, we had to step away from the transaction due to the lack of visibility surrounding COVID-19. But after seeing the rebound off the April low and delivering strong May and June performance, we decided to renegotiate the acquisition under more flexible financing terms and more favorable pricing. We are pleased that our business model and performance has allowed us to navigate the current environment and reengage on this highly strategic acquisition that we believe will make us an even stronger company. Park Place is one of America's largest and most predominant luxury dealer groups, and they are regarded as one of the best and most efficient operators of luxury stores in the industry. Park Place has a strong base of loyal clients and long-tenured teammates. We have had great success acquiring large well-run stores, and we fully expect Park Place to be equally successful. We believe Park Place will transform our company over the long-term for the following reasons. First, this acquisition is intended to meaningfully scale our business, increase our revenue by approximately 25% and transform our revenue mix from luxury of 36% to 49%. The luxury segment has historically delivered strong and stable margins that are significantly above those achieved by midline imports and domestic brands. Luxury stores are most resilient in downturns, have higher and more stable margins, have fewer dealers nationwide and derive a higher portion of gross profit from parts and service. Second, this transaction is expected to increase Asbury's geographic mix to 28% of its revenue derived from Texas. Texas is the second largest car market in the country. The Dallas market has a 30% higher penetration of luxury new vehicle sales than the national average. Dallas is home to 24 Fortune 500 companies and has had some of the highest population growth over the last decade. I've lived in Dallas and it's one of the best, if not the best, luxury car markets in the country. Third, the combination of Asbury and Park Place is intended to build a company that derives approximately 50% of its gross profit from parts and service. Currently, Park Place generates 56% versus Asbury's 48%. Huge amount of our focus over the last decade has been growing our parts and service business. This is a higher-margin business, is more stable in downturns, has a higher gross profit flow-through to income, has more organic growth opportunities and the customer is 70% more likely to buy their next car from you. This acquisition is expected to enhance these opportunities and improve our margins and the resiliency of our business. Fourth, in addition to synergies and performance improvements identified, there are opportunities for organic growth. We have a strategic growth opportunity to build out the Park Place auto auction and their 2 collision centers. Fifth, and most important, the people. Park Place built large award-winning stores with exceptional reputation for delivering in an unparalleled guest experience. It takes long-tenured dedicated team members with strong processes to achieve these results. We believe that bringing together what Park Place does best and what Asbury does best will drive significant shareholder value, and it will bring us closer to achieving our vision to become the most guest-centric automotive retailer. Finally, I look forward to welcoming all the Park Place team members. We look forward to working with you. I also want to thank all the Asbury team members and our on-site partners who have helped us with this transaction. We truly appreciate your support. I would now like to introduce our new CFO, PJ Guido. PJ is new to the team but has already made a huge impact on this deal and to our entire team. We look forward to him making a meaningful impact over the coming years. Welcome, PJ.

Thanks, David, and good morning, everyone. I'm excited to be part of the Asbury team and look forward to getting to know our investor and analyst community. I've spent the last several weeks getting up to speed on the company, and one of the most impressive things I've seen is the strength and flexibility of the Asbury business model and pace at which we have been able to adapt to the current environment. David briefly touched on performance, but I feel it is important to call out that given a variable expense structure and proactive cost management, we have seen positive earnings and cash flow in each month since the COVID-19 pandemic began. With better visibility and good performance, we can confidently move forward, acquiring some of the best luxury stores in the market today. Moreover, we believe that buying the Park Place stores, which have attractive margins and operate in one of the largest and fastest-growing markets in the country, will make us a stronger and more diversified company, even better equipped to succeed in the current environment and well beyond. Acquiring the Park Place Dealerships is expected to add an estimated $1.7 billion of annual revenue or 25% top line growth based on 2019 revenue. We are also buying attractive EBITDA, forecasted to reach $95 million within the next 3 years after factoring in estimated run rate synergies of at least $20 million. The purchase price, excluding inventory, of approximately $735 million includes $685 million of goodwill and $50 million for parts and fixed assets. This reflects a 7.7x multiple on the expected $95 million of EBITDA and $20 million of run rate synergies. In addition, we expect $10 million in annual cash tax savings from goodwill amortization, which equates to approximately $80 million in present value. The acquisition terms also allow for us to lease real estate assets worth approximately $217 million for an initial term of 10 years with options to purchase. Assuming a closing sometime in the third quarter, the transaction is expected to be accretive to 2020 earnings per share. Net accretion includes pretax transaction costs of approximately $0.20 per share in Q3 2020. These costs are mainly related to legal, audit and other outside consulting-related fees. The transaction is expected to be funded through a combination of existing credit and mortgage facilities, seller notes and cash on hand. Net leverage at the time of closing the transaction is currently forecast to be approximately 3.6x, above our target of 3.0x. Although we anticipate that leverage will fluctuate over the coming quarters, we believe the accretive nature of the deal, the improved combined cash flow generation, the increase in luxury parts and service mix combined with Asbury's organic growth, will allow us to proactively manage our balance sheet and get back to our target leverage of 3x within 18 months. Before closing, I would just like to offer some additional insights on Q2 performance. On a same-store basis, we have seen new and used volume progressively improve throughout the quarter. In June, we saw new volume reached close to 85% of the pre-COVID period from a year earlier, and used volume actually grew by 1% compared to the same period last year. We've also seen parts and service traffic increase, with June gross profit reaching the same level as last year after falling by 47% and 37% in April and May, respectively. I would also like to point out that we expect SG&A for the second quarter to be approximately 63% compared to 68% for the same period last year. Our SG&A for April, May and June also included guaranteed payments we made to our active employees and health care benefits paid to furloughed employees in order to support and retain them during this period of uncertainty. While we are still finalizing all June results, we are estimating $40 million of pretax income in June, which is actually over 100% higher than last year. We expect to report a total of approximately $65 million of pretax income for the full quarter, a net increase of 4% versus Q2 of 2019. For additional details on the quarter, please refer to our press release dated July 6. We look forward to providing you with full details in a few weeks on our earnings call. In closing, we are extremely excited about the Park Place acquisition and its potential to create long-term value for our shareholders. We will now turn the call over to the operator and take your questions.

[Operator Instructions] We'll take our first question from Rick Nelson with Stephens.

Nice quarter. Good work.

Thanks, Rick.

Thanks, Rick.

I'd like to ask you about the cost cuts. You talked about $15 million monthly coming out of the business. How much of that do you consider to be a permanent cost reduction? And how much is likely to come back?

Rick, I'll answer it as best I can. For years, our whole space has been saying we can perform well in a low SAAR or high SAAR environment because we have a collapsible business model. I think we just proved that the dramatic drop to an 8 million SAAR and what happened in that time frame, how quickly we reacted, and I'm sure our peers did the same. We took all those costs out to run the business at that time. Since then, we originally furloughed 2,300 people. We brought back about 1,000 people at the end of May to run our business. So what I would tell you going forward is there's a fair amount of that expense that will stay out. I really don't want to quote an exact number because we're going to stay flexible to the business environment. But I think, hopefully, our track record will show that we'll be very disciplined in managing it.

Great. Also Park Place, if you could help bridge the EBITDA. Previously, you had talked about $100 million in opportunity there. Now it's $95 million, but you're not buying the real estate. If you could help us there, and any insight into the lease terms? I know you mentioned that it was 10 years with an option to buy, but how about the rent factor there?

Yes. Rick, it's PJ. I'll take that one. At a high level, there's obviously some ins and outs, but I'll just walk you through the bucket. So from your $100 million number, obviously, we take out the EBITDA associated with the open point as well as the premier stores or the premier business. We adjust for the trend -- the current trend in new and fixed gross. Then there's reductions in leases and rent costs. There was some dis-synergy or some expense associated with the select business, which we're not taking on, and then additional cost reductions across the business, which include things like head count, but other costs that we found additional synergies. So those are the -- that's what comprises the difference between the 2.

And just to add to that, Rick, I would say open points, when awarded by the manufacturer, you don't pay for. In this particular circumstance, we paid goodwill for this deal, for that specific store, and we didn't have it making money for the first couple of years. Open points is tough to get up and going, so we prepaid for the land, we prepaid for the goodwill, and we didn't really factor in any returns for the first couple of years. The ultra-high-end luxury happens to be on very expensive dirt. It's low volume. It wasn't a significant contributor to the EBITDA. So that too played a role in it as well.

Got you. And if you could speak to Texas and Florida, I guess, late June into July. Any commentary there since we've seen this recent COVID outbreak?

Yes. I'll do my best. And I don't think anyone on the call has the answer to this one. We're living through this time. We're not naive enough to think that we're through this by any stretch. We see that the country is opening back up. We see the cases getting higher. We see the hospitals doing a better job at treating folks and turning them out of ICU quicker, but we're still in the middle of the pandemic. Our business is still affected. You can still see it in the SAAR. I think people are a little bit more resilient and want to come out. We've proven that this model is essential and oddly, with what's going on in the world, private ownership of vehicles certainly seems to be a preference right now and the propensity for people to spend in automobile, as seen by our numbers and our peers', is certainly there.

We'll take our next question from John Murphy with Bank of America.

Congrats on some great short-term performance here and getting this deal done. It's pretty miraculous stuff, all things considered. I'm just curious, just to maybe follow-up on Rick's question on the cost side. Maybe when you look at the SG&A to gross in June at 55%, that's a great number. Traditionally, you kind of run in the mid- to high-60s. Just curious how you think about that SG&A to gross going forward. Is that the kind of thing that this -- you've been sort of enlightened maybe by the great performance in June, and there might be some other things that you -- or action that you could take structurally going forward? I mean just how should we think about that sort of percentage to gross over time? And what kind of opportunity could there be?

Sure. I'll start it and then PJ will come in. That 55% number looks pretty strong, but it's really not sustainable at that level. We've had a tough year in the country with all things going on, but we had things line up for us in June. We've always said that we're a Southeastern company. What I mean by that is we're not in the high-rent district, so our fixed expenses are low. And that gives us a lot of flexibility to really get our expenses down with low fixed costs. In the month of June, you had quarterly money ending from the OEMs, you had high margins on new and used, high margins in parts and service, low inventories, benefits from SG&A cost, floor plan expense, everything just wound up really well for us to deliver such a strong quarter -- to include lower health care costs in the quarter as well. So everything just went our way. It's not sustainable to stay at that number. We would probably still guide to the 66% to 68% range. But again, we're still in uncharted waters to know what's going to happen going forward. PJ?

Yes. I think David said it well. At 55%, we don't anticipate that to continue. We are picking up significant benefit from things like we have lower inventories, the lower floor plan costs, interest rates remain significantly lower. So as those rise, obviously, floor plan cost would rise as well. So I think 55% for June, 65% for the quarter, the 67%, 68% range is a good target, but they'll still -- we'll always look for opportunities to improve upon that.

Okay. That's very helpful. And just a second question on new vehicle sales. It sounds like you were inventory-constrained and managed to help out future months. I'm just curious if, as you look at the demand there relative to inventory, if we're going to see sort of months that are constrained and sort of this down 16% in June is -- this will be probably, might be more indicative, the next few months or if you're being restocked with inventory from your -- the OEM partners, just curious how that's going to play out.

Sure. I mean everyone's back in production and we see cars coming down the pipeline. July is going to be tight. It's going to be tight for everyone in the country, and the numbers might be a little deceiving. My opinion as of today is the demand out there is much higher than the supply. So that should certainly benefit margins, but it's also going to be deceiving in cost of unit sales. I'm sure as August rolls around, certain brands will catch up with inventory, not to the levels that you'd want, but certainly from a replenishment standpoint. And hopefully, we'll have a stable Q3 and then get back to normal inventory levels by Q4. It's kind of the way we see it right now. Obviously, that can vary slightly by brand.

And that's helpful. And then on the used side as far as inventory, I mean, it seems like you're at the will of the market as far as what you're paying. Obviously, you're doing a good job with strong grosses. But I mean as far as the inventory on the used side, I mean, is it available to you? And can you keep the strength of used going if the demand keeps going there?

Sure. What we saw in March and April, I think we saw a 14% drop in valuation of used cars. And I've never seen that kind of drop in my 34 years of retail in that short a period of time. Some people chose -- got nervous and fire-saled inventory. We didn't. We sat on it because I just knew that valuations weren't real. And I don't think this is a game for us, that we're going to chase volume on used. It just doesn't make sense. Our ability to make money on a car is solely going to be based on the acquisition of a car because the market dictates the price. So we're really focused on profits and returning profit. So we're comfortable -- if we can continue with margins like we're showing the last couple of months and volume's flat, we're more than okay with that. We're trying to be creative, sourcing cars out there, but there's a fine line between sourcing what you need for inventory and getting aggressive and overpaying for inventory. Overpaying for inventory and creating lower margins isn't going to benefit anyone. So we're thoughtfully looking at this every day. And going store-by-store, being strategic as to how we can acquire inventory. From what we've done in the quarter and what we see currently, we feel comfortable that we can continue on with our current pace.

Okay. And then just lastly, on the deal itself. I'm just curious, as you went down from 19 to 12 dealerships, how that was actually reset and the thought process there. I mean I can understand it was sort of the premium luxury or the ultra-high end that was taken out of the deal. I'm just curious how you decided to reset things and what remains with the owners of Park Place as they stand right now. And then also, David, it looks like the framework agreements, particularly around Lexus, are being loosened, and you're giving -- you've been giving some kind of preferential treatment, at least on Lexus, but it seems like on some -- maybe some other brands as well on national framework agreements. So just curious what is changing there as well.

John, if I missed something, please let me know and I'll answer it. Regarding Lexus, we have a great relationship with Toyota and Lexus. We do with all our OEM partners, and we value their relationship and partnership. I certainly wouldn't say preferential treatment. And we'll certainly have to work with them again on all these transactions to see what the outcomes will be. We're confident that everything will transpire and transact and close in this quarter, and we'll certainly listen to our partners and certainly let them guide us as to what to do. As far as the deal structure, there's 2 sides, and I don't really want to speak for the seller. We're thankful that they reengaged with us. They were engaging with other folks as well. We spent 8 months with them, getting to know each other. I met all their employees in 33 different meetings. We felt strongly about the assets, but we also had to be realistic about the current structure and the time that we're in right now and what's going on in the world. And we tried to work together thoughtfully to create a win-win situation where the seller was able to accomplish what they wanted, and we were able to accomplish what we wanted as far as acquiring the assets that meant the most to us, and really making sure we structured the deal to make sure we can weather it in all times, and that it was going to be accretive and add value for us. And we think we accomplished that. We see this as a very strong deal. And it's really -- when you look at the prior deal, $100 million in EBITDA, and this deal at $95 million and the price reduction, I think we perceive it as favorable for us.

And maybe just a last one, real quick on the deal. The $20 million in synergies to get to $95 million of EBITDA, I mean, it basically means you're starting with the base of $75 million in EBITDA and getting $20 million in synergies, which seems like a big number relative to that $75 million. I'm just curious, what are the major buckets of that $20 million?

Yes. I would tell you, it's a private group, and it's a large private group. And large private groups have large cost structures. We also have national vendor relationships and insurance costs that are significantly lower than what they have. So well over half the synergies there is just in taking out the compensation and corporate expense and SG&A expense that just isn't there in our business model. We actually see more potential in growing the business in other areas, and we called that out in the IR deck that we sent out, of additional operational income output. So when we looked at this the first time around, we said $20 million. It's $20 million now. There wasn't a lot of synergies with an open point that wasn't open yet and the small ultra-luxury stores. And we still got the core base. And they, too, like we did, furloughed a lot of associates as well that we didn't have gone in the first model.

We'll take our next question from Bret Jordan with Jefferies.

I guess if you look at the parts and service mix being higher at Park Place, could you talk about how the margins compare in luxury parts and service versus your company average?

They're higher in all categories.

Okay. Sort of order of magnitude higher? Or just -- should we think about it just being higher?

We had pretty good June numbers, as you can see. I would say if you go off our historical numbers, they typically run 4% or 5% higher in margin in parts and service, and they're higher in new and used car margins as well. Our F&I numbers are larger than theirs.

Okay. Great. And then on -- you talked about the auction business in your prepared remarks. Is that something that you think about expanding in your legacy Asbury operations or getting -- broadening the wholesale auction business?

The auction business is a very profitable business. The seller chose to open this auction to facilitate the sale of his used vehicles. He only chooses to run the auction 1 day a week, and he only chooses to allow his cars to run through it. We see some opportunities with our stores to run the auction more days and to grow that business. As far as where it goes from there in the future, we have a lot of experience acquiring cars at auctions and doing business with auctions, but not running auctions. We want to learn, run this one, see what it looks like. See what the potential is and then make a decision moving forward if this makes sense to expand this model or not.

Okay. And then a final question. You mentioned that 20% of your used vehicles were online transactions. Is that something you think is sort of a continuing trend? Or was this a shorter-term reaction to the pandemic and a bias back to physical interaction?

Yes. I think it's a combination of all of it. We've been focused on this for 4 years. We've been quoting 10% numbers each quarter as part of our business. I think we jumped on it earlier than most. It's been a sole focus of ours. And we're certainly in the middle, and have been for months, at trying to enhance it from what it currently looks like online now. So we're very competitive in this space. And it's something that we're aggressively looking at and focused on.

We'll take our next question from Armintas Sinkevicius with Morgan Stanley.