AutoNation, Inc. (AN) Earnings Call Transcript & Summary

Good afternoon, and good evening, everyone. Thanks, everyone, for joining us. My name is Rajat Gupta. I'm a member of the Automotive Equity Research team at JPMorgan. Very excited to have with us today Joe Lower, CFO of AutoNation; and Rob Quartaro, VP of Investor Relations, joining us today. We'll start off the session with a quick few minutes of overview from Joe on the company, after which we'll dive into Q&A. For the audience, if you would like to ask a question, please do so on the online portal. And I'll be happy to answer that question on your behalf. Or you could also e-mail your questions to [email protected], and we'll make sure to ask your question. With that, I'll hand it over to Joe. Thanks, Joe.

Thanks, Rajat, and good afternoon, good morning, good evening, everybody. Great to be with you today. I just wanted to just take a couple of minutes, almost as an introduction, just to provide a couple of my perspectives on the business. Just very quickly reiterate our Q2 results. And I just want to touch on what we're seeing in July. And for those that don't know, I've been in AutoNation now 7 months. I was previously the CFO at B/E Aerospace and prior to that -- or after that, CFO at Office Depot. And so it goes without saying that it has been a remarkable 7 months, an incredible learning experience and to musically shape kind of baptism by fire, but I wanted then to just kind of share some of my perspectives that I've gained very quickly in a 7-month period, I'll be succinct. First, I've come to appreciate very quickly size, strength and reputation matter. AutoNation is the largest and really most recognized automotive retailer. We've got more than 325 locations. We offer more than 30 brands, and we've got a very diversified business model with only 25% of our gross profit actually coming from the sale of a vehicle, 75% of our gross profit coming from ancillary services, from offering financing or facilitating financing, ancillary products like insurance, debt repair, tire services, collision services or selling aftermarket parts. When it comes to strength, we're the only auto retailer with investment-grade ratings. We've got a net debt-to-EBITDA of 2-point times leverage. We have over $1.6 billion of liquidity. And when it comes to reputation, almost 25% of our dealerships -- actually we were awarded the J.D. Power Quality award, and we have the highest scores in Reputation.com. Second thing I've learned is to use another cliché, never let a good crisis go to waste. And in the short period of time that I've been here, we have been extremely aggressive in taking actions to reposition the cost structure, including the capital spend; permanently reducing head count; addressing discretionary spend, including advertising to reposition us from a cost standpoint. We basically have seen over a 500 basis point improvement in SG&A as a percentage of gross in a 2-year period of time, and we're committed to continuing that discipline going forward, both on the cost and the capital side. Third thing that has become very apparent to me in this industry is digital will differentiate. Those that have the wherewithal and the willingness to invest will be able to differentiate themselves in the marketplace. And that's not simply a website, that's about putting the power of data at the hands of your sales force and your service staff. So they are more empowered, more informed to more effectively sell, that generates much higher effectiveness and can lower your advertising costs. The third thing that I've come to appreciate is the lessons that we've learned in the AutoNation USA used stores that we set up, now position us to move forward with high confidence that we can expand that footprint. We announced that we're going to open at least 20 new outlets over the next 3 years and have confidence in the business model that, that will generate significant returns. So a very quick period of time for me to come to appreciate these kind of critical drivers for our business really do differentiate us in the marketplace. Second, just spend a minute on Q2 results. I think most folks would say truly remarkable to think that we would record 18% adjusted EPS growth year-over-year and actually record an all-time record quarter. You would have thought in April or May that never would have been possible, and it's truly phenomenal how quickly the business recovered. Just for those you that have not followed the story closely, just for some perspective. If you look at same-store new units, in April, they were down nearly 50%. By the month of June, they were down only 13%. If you look at same-store of used units in April, they were down 60%. And by June, they were actually up year-over-year, 14%. Our customer care, which has been a little slower to recover, if you looked at the average service per day, it was down about 40% April and then it recovered to down about 10% for the month of June. And so as we look at July, when you talk about new units, you have to talk about inventory. Inventory is tight. It is limiting sales. Inventory levels are unlikely to fully recover depending on product and brand. Some Q3, some Q4, some as early as Q1. I think, in general, as a broad statement, Domestic will recover most quickly, Import thereafter and Premium Luxury probably lagging a bit. But if you look at new unit sales, they were down 16% in July, and I know that was clearly impacted by availability of products. Used inventory is tight, but not nearly the dynamic. And we have been very successful in sourcing from our We'll Buy Your Car program. Units were down 4% -- pardon me, units were positive 4%, I apologize. Units were positive 4% year-over-year for the month of July. And for both new and used and for CFS, the PVRs have remained strong. I know we'll probably talk more about that. But clearly, the environment has facilitated that. I think as inventory levels recover, obviously, they will have an impact on the PVRs going forward. And then customer care has continued to improve. I mentioned it was down 10% in June, down just 4% in July. So we see continued positive trends. I think, as I said, inventory is probably the one limiting factor right now on new sales, but very optimistic about the outlook. With that, I'll open it up for Q&A.

Great. Thanks for that quick overview, Joe. And I just wanted to start off with just a very high-level question on just the macro environment overall. We've heard some mixed commentary over the last couple of days from the other participants. It looks like demand hasn't really necessarily deteriorated versus June levels, but it's been described more as steady versus June. And I mean stimulus checks are now potentially going to be lowered versus what they were prior. They might roll off at some point. But then you have the offsetting factors of just more need for personal transportation, trend towards deurbanization. So in your view, given your proximity to the consumer, how do you view like just the health of the market, in general, you're in the second half, going into the second half and into next year, just in terms of just demand for vehicles, keeping in context all the other factors such as unemployment, stimulus, et cetera?

Yes. I would say, if you try to sum it up, I would say we're cautiously optimistic. The stimulus, clearly, potentially will play a factor as we get later in the year. I think that's clearly a potential catalyst for additional demand. You mentioned the need for personal space, private space, whether that's for work or recreation. I think we all know many, many stories of people that are talking about driving versus flying, whether it's their vacation or their kids going back to school or how they're going to start going back to work. I think all those things are going to contribute to continued demand. And I think you're going to continue to see incentives as coupled with low interest rates. I think all those things are generally going to be positive tailwinds or catalysts in kind of, obviously, a broader questionable economic marketplace. So again, cautiously optimistic, watching it as everyone as very closely. We're watching delinquencies and whatnot. And we're not seeing any real alarming or concerning signs and have a positive outlook.

Understood. Okay. That's helpful. And you gave us some good color on July. I mean I think you were up 14% in used in June and 4% in July. I mean it's still pretty healthy. But it looks like it moderated a little bit. Like how -- I mean you may not quantify this, but like, how has August been so far? Has it continued at a similar clip? Has it accelerated? Is there a little bit of a pause here given there's some uncertainty around like the new stimulus checks? Just curious.

Yes. I'm not going to get into specifics, but I'd say the trends have generally continued.

Okay. And on the used side, you mean, you talked about supply probably easing at some point. Is there any visibility that you have right now? Like is it a crystal ball? Like when we can see that supply-demand dynamic easing out here in the near term? Or you already gave us some color on the new side on the margins, so looks like that could remain healthy for an extended period. Like how should we think about the used side of things? Can we sustain these kind of margin levels for a few more months? Or are you starting to see supply come back there?

Well, the supply -- for us, at least, the supply is not nearly as significant a factor in used as well as in new. I mean our We'll Buy Your Car program has continued to have month-over-month incremental success. So I'd say, in general, our inventory levels are about where we want them to be. So again, I do not see it today as a supply problem for us in used. We obviously watch it. Again, I think the combination of availability of new, strong, nearly new market, I think all those things are helping profitability across all sectors. But again, I don't see the new dynamic applying to the used marketplace right now.

Got it. And with the We'll Buy Your Car program, I mean that's probably helping you maintain supply, but the fact that you're sourcing more from customers directly. That also, in some way, should benefit your GPU levels, right, versus just increasing that mix of retail sourcing versus auction. Is that fair to assume?

Correct, correct. I mean our trade is clearly our #1 source of vehicles. We'll Buy Your Car supplements that. And then we rely on auctions kind of as a buffer, if you will, to fill needed capacity or needed space.

It helps fill in because, obviously, because of the tight supply on new and new units being down in midteens. It helps supplement those loss trades that we would have got on the new side as well.

Got it. Yes, that makes sense. On parts and services, I mean, it looks like July is continuing to see a recovery in the year-over-year trends. What in your view -- I mean, Sonic puts out their forecast for the rest of the year. They see a continued recovery in the year-over-year trends into the fourth quarter. I mean they are more California exposed, so might see a little bit more of impact. I mean you are too. So are you expecting a continued recovery in the year-over-year rates in parts and services into the rest of the year? Or do you think it might stagnate at this kind of a level in the near term?

I think we expect it will continue to recover. The part of the business that has lagged a little more than other has been collision repair. And that's understandable. You've got fewer people driving and fewer collisions. I mean it may be good thing for the health of Americans, but not good for the business. But I think you're going to see that recover as you get into the fall and people are going to start using the vehicles more. So I think that will be helpful. That has been a laggard through really this whole COVID-19 pandemic.

Got it. Okay. That's helpful. And on the F&I side, I mean, industry-leading GPUs for you, you continue to surprise us to the upside there every single quarter. What's the secret sauce there? I mean is it just -- I know you've had this brands initiative for a while. Is that a major factor here? Is it continued increase in penetration? Is it just a mix? Is it the financial institutions through which you do the lending? Like how does one get comfortable that, hey, we're not at like a peak here and it cannot grow further, but there are other factors that are actually driving that higher and higher over time.

Yes. I'll give my perspective. I'll let Rob way in as well. I'd say, it starts with, obviously, a very deliberate strategy of developing some unique products, right? And when you look at F&I, I think you know this, I mean, 1/3 of it is kind of financing, 2/3 of it is ancillary services and solutions. So it's not just are we financing. It's all the other things along the offerings that we're providing. I think we have very compelling solutions. I think our sales force knows how to sell. And I mentioned earlier, this power of digital, and I think a lot of people who have talked digital, they want to talk omni-channel, they want to talk about your Internet delivery. That's one part of digital. But frankly, a more powerful part of digital is providing your sales force the tools to know the customer much more intimately than previously. So we know what a customer's history has been with us as we're sitting with them. We know what kind of products they bought. And we can be much more thoughtful about what solutions we offer. And I think that makes a difference in our effectiveness in selling solutions, again, particularly beyond just the financing products. So we believe it's a differentiator, and we believe it will continue to be a strong part of our business.

That makes sense. I just wanted to quickly go back to parts and services. With the parts extension initiative that you've had for a while, a question we get a lot is, how are you competing with the independent aftermarket providers out there? And I think AutoNation, specifically, just given their brands and parts initiative, you're probably positioned in a better place to compete with those independents. How should we think about share shifts in that side of the market going forward? Can we see a lot of this gravitating towards the franchise dealers away from the independents over time?

Rob, do you want to take that one?

Yes. I think there are fundamental tailwinds that do benefit the franchise dealers in terms of the increasing complexity of vehicles. The alternative materials they're using like aluminum, alternative drivetrains, all those things require additional investment in training and technology and facilities and so the dealers are obviously well positioned to capture that business. It makes it much more difficult for the independent repair shops to keep pace with all the technology and training required. To your point earlier as well, we did roll out private label parts and accessories a few years ago. And so that -- and it also enables us to offer a lower cost alternative to the manufacturer part for our customers, while also benefiting our margins. So we do feel like we are very well positioned for the long term to continue to take business from the independent repair shops.

And the only thing I'd add -- thanks, Rob. The only thing I would add is, it goes back to really the CFS. I mean one of the other things we've done is effectively sold service. And obviously, trying to get that lifetime value out of a customer, a big part of that is making sure you get the service. And with the service, obviously, you control some of the flow of the parts. So Rob is absolutely right. I think the greater the complexity, I don't know about you, but you open the hood of a car out, you don't even see the engine. There's no way you can touch it if you don't have a significant computer. All that makes it more complicated, and we're doing everything we can to make customers realize they're best served by letting us serve them. So...

Got it. That makes sense. I just wanted to just move to the digital topic. We also have a question coming in from the audience. So that's a good segue into that. I mean what we have heard consistently through the conference and through the earnings season was that there seems to be -- there seems to have been an accelerated shift in terms of consumers, willingness or comfort in terms of transacting big ticket purchase like a car online and doing the full transaction online to the extent of getting it delivered to their homes. So the question from the audience here is like, clearly, the used side is going through a huge change. And you talked about some digital investments that you've made over time. How do you think your presence compares to Vroom, CarWale shift? And obviously, you know about Lithia's driveway.com launch coming up. Where do you fit within that? What can you improve or you can get better at? And how long will that take over time?

I think if you have to take a step back and what model is you really providing that, the one thing, and I understand, obviously, a lot of excitement over the digital offerings and whatnot. But what we find with our customers, and by the way, we will do and offer or whatever our customers want. However, they want to be served, we'll serve them, let's be clear. But a remarkably small percentage of our customers want to have their entire transaction be digital. Very, very, very small percentage. Now it's going to be relatively soon, half of them are going to have started their transaction online. And clearly, in an environment like this, you can appreciate it, right? I want to do as much searching and evaluate it as I can online before I go in. But our customers, at the end of the day, at some point, want to touch and feel the vehicle before they make that commitment. So that is a tremendous differentiator for us, which clearly, we are not going to abandon. We have the ability, obviously, to deliver door to door. That is not an issue. But as I said, to me, the battlefield, in some ways, with digital is making sure you have all the power with the associates that they can be as effective as possible in serving the customer. Because the best website at the end of the day, I'm not sure, is going to win the long-run game. And clearly, the other part of the equation is then how do you provide service, how do you actually facilitate some of the touch needed in the industry and that's clearly a leverage point we have with really the largest footprint in the industry. So our digital strategy is how to complement that accelerate the successfulness, not abandon it. That to me is really the digital battle is, not to replicate what they've done, but how to take digital-type capabilities, how to take data and make us more effective in serving customers. And that to me is really the differentiator. And that's, frankly, where we have spent a significant amount of money in both our digital mining and our, what we call, Customer 360, our customer relationship management software, and making sure we have those tools at the fingertips of our associates.

Got it. Now I think that makes a ton of sense here. I think that's a good segue into the SG&A and the cost cuts. I mean one common theme through this earnings season has been that all of a sudden, all these -- all the publics have just generated so many efficiencies out of their cost structure, anywhere from 10% to 20% of headcount reductions, which could be permanent in nature. What's driving that efficiency increase overnight? I mean is it -- it looks like digital is a big aspect of that when consumers are just spending more time online, doing a lot of the transaction -- portion of the transaction online, including financing. So how should we think about your SG&A profile going forward from here? You were at 68.2% in 2Q. Can we ever see you going higher than that now even through the AutoNation USA rollout? And also like how has your model just gotten so efficient within, like, such a short frame of time?

Yes. I'll go back the comment I made -- I'll answer the question in full, but I'll go back to the comment I made in my opening, we never let a good crisis for the waste. And I've had either the good fortune or unfortunate of going through a number of crises through my tenure as CFO. And that's a moment where you make some tough decisions. That's sort of a moment where you make tough decisions on people and discretionary spend. And I think the real question is, can you maintain the discipline going forward? Because this -- I think for many of us, but I think, for us, it's not about are we going to take the cost out. The cost is out. The question is, what do you do to ensure it doesn't come back? And we have gone a long way in trying to ensure that doesn't occur. I think digital does enable people to do things more effectively with sales force. And in some ways, again, this crisis, if you will, let people kind of go some place much more quickly than they might have gone otherwise. As you know, it's not easy, particularly with a successful business to say, let's fundamentally change how we're doing things. And so I think we're at least taking advantage of the situation, as unfortunate as it is, to say, "Okay, we've taken these people up. We're not going to bring them back. Let's, in fact, leverage the capabilities, let's leverage the technologies. We're moving more to a digital marketing environment. We're reducing discretionary spend. Let's ensure that doesn't come back." And clearly, it's being benefited in the near term by a healthy PVR market. That clearly helps for every dollar. If you can make a little more profit, that helps all the way to the bottom line. But we're very sincere in saying, we are going to maintain this discipline. Mike was unequivocal about that on the call. You should assume that all of us in the leadership team understand and are committed to it and intend to drive that going forward.

Got it. So I mean we shouldn't be expecting like a sequential uptick here in SG&A to gross in the second half versus 2Q? Or could we see a temporary blip and then it starts to come back?

It will be a bad day for me if it ticks up.

Our stated target is to be below 69%.

Got it. Okay. That's helpful. Yes, we have a few minutes left. I just wanted to get into capital allocation. I think, in my view, what's changed a lot from last year is how significantly or how attractive your balance sheet has -- how much it's improved over the last year or so. You clearly generate a ton of cash. And now you have the stake in Vroom, which could be up for monetization at some point. So 2 questions there. What do you -- what should investors expect you do with the Vroom stake? And then two, clearly, you've already given us some detail on your capital allocation pads towards AutoNation USA, the 20 stores that you're going to build. But just given the amount of free cash flow you generate, I mean, AutoNation USA does not seem like a very capital-intensive launch. So where do we expect the rest of the capital to be deployed? Is buyback is going to be the major focus there? Or could you -- or we could see you growing the company even more through more franchisee acquisitions?

Yes. So let me start with the easy one. So you asked about Vroom. We're not a venture capital firm. Vroom was made initially as a strategic investment, that relationship has kind of grown, if you will, and grown different directions. We'll look at that appropriately. So I'm not in a position to state what we're going to do, but it's an investment. And we'll look at it appropriately when we have that flexibility, as we -- as I think people know we're under a lockup. So in some ways, our hands are tied, part of the phrase. Going to the capital allocation, obviously, if you look -- and it was a great fortune, if you look last year, as you said, we paid down significant debt and delevered the balance sheet quite significantly. And if you sat here in March or April and May, you were extremely appreciative of that when no one really knew where things were going. As I mentioned earlier, we had the benefit of having really the strongest balance sheet in the industry. And as we look now and this pandemic appears to be something that is much more manageable, we've demonstrated the ability to flex not just the cost structure, but the capital allocation. I think it gives us and gives me more confidence in our flexibility of capital allocation. Clearly, the first priority is always investing in the business. There's almost always the highest returns. The first priority is clearly now AutoNation USA because we see a very clear path to an attractive return. We stated that. And clearly, that is a priority for us. We'll always be opportunistic on M&A. But candidly, opportunities are somewhat limited because we are pretty disciplined in making sure there's an adequate return and those that are available have generally gone for pretty, bywords, lofty prices. And so I would not -- I think that would be opportunistic. It will not be a "priority" or something that we're going to lean too far forward on. And you mentioned share buyback. I mean the company has a very long history of buybacks. So if you want to say philosophically, that's clearly something that the company is very comfortable with. And clearly, as we go forward, it will be opportunistic and it will be market-based. And frankly, as -- and in, obviously, just a phenomenally short period of time, we've gone from crisis, and as you know, everyone was hoarding every dollar to greater confidence now that we can deploy it with confidence. And so that's one of the things that we are going to be doing over the remainder of this year, is really laying out how that's done thoughtfully, if you will. The first market we've put out is a plan to grow the AutoNation USA, and we'll continue to be opportunistic and disciplined as we go forward.

And so what level of leverage do you think you would be comfortable with, with the buyback? I mean you're at 2x right now. Like would it be unreasonable to expect that you've done some buyback and maybe levered up by the end of the year? Or is it just going to be the excess free cash flow that's deployed that would go into buyback outside of acquisitions?

Let me answer that in 2 questions -- 2 ways. One is, first talk about the leverage. So we have operated between 2 to 3x historically, I think, very comfortably. And from what I've seen and kind of what have experienced, I would say those are generally comfortable levels. So that answers the question on kind of where I think we fit from a leverage standpoint. If we dip below for a period of time, I doubt it to be for a long period of time, it wouldn't be a deliberate effort, but we're going to be prudent. Clearly, as it relates to buyback, it's going to be opportunistic, if that makes sense. We clearly have demonstrated in the past a willingness to invest relatively aggressively. And I'm relatively confident given what I've seen that, that would be the approach we would take again. But that will, obviously, be based on market conditions, both outlook for the business, the dynamics and the share price.

Got it. Makes a ton of sense. Just 1 last 1 here as you're bumping up on time on AutoNation USA. You've given us this long-term 3-year plan. Any color you can give us in terms of just the profitability of these stores we should be expecting over this 3-year period? I mean the only reason I ask is in the context of some of your peers like Sonic and Lithia who've actually put out numbers and like pretty aggressive target. So just curious if that is something you're able to provide? Or should we expect you to maybe give that sometime in the near future once you have the plan more laid out in a detailed manner?

Yes. As we said, our plan is in Q3 to provide a lot more detail. We wanted to, at least, in part, because we're actually taking actions underway. And as you can appreciate, trying to find that balance with maintaining confidentiality. So we felt the need that we needed to announce that we were doing this. But our plan of Q3 is to provide much more detail on the fundamental economic model and what the outlook of that would be, at least for the initial 20 stores, though I think we were pretty clear in saying at least.

Got it. We just have 1 question from the audience, I wanted to throw in there. The less than 69% SG&A to gross target, what minimum level of retail SAR do you need to achieve that? Or is that pretty much independent of that?

I'm very reluctant to tie it to a SAR. There are -- I mean, I think we've seen here. The PVRs are a significant factor in that. Related customer care is a significant factor in that calculation. So I'm reluctant to say SAR because, candidly, I don't think of it. I don't think, we don't think of it that way. We think of it as the dynamics of those other variables. And how those will interact, right? So that, to me, is much more significant than the SAR itself.

Got it. Yes. Okay. That makes a ton of sense. I think we're out of time here. So thanks so much for presenting and sharing the thoughts. It was super useful. And look forward to having you again at the conference next year.

And look forward to seeing people in person.

Likewise. Yes.

Thanks, Rajat. Appreciate the opportunity.

Thanks, Rajat.

Thank you for joining. Thanks, everyone.