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

Great. Okay. We'll move along. A company that has been with us for many years in the past, both virtually last couple and here in Las Vegas. We're delighted to have AutoNation back with us and company's Chief Financial Officer, Joe Lower; and Vice President of Investor Relations, Robert Quartaro. AutoNation is based in Fort Lauderdale, is the largest automotive retailer in the U.S. There's over 300 new vehicle franchises and about 230 or so stores, has 32 different new vehicle models and has one of the more exciting stories, I think, within automotive retail in that it's a company that is transforming its used vehicle strategy through its AutoNation USA stores. At the same time, it's undertaken significant efforts over the course of the last 2 years to optimize how it runs its business in this environment, and we'll get into this that where it's really the best of times in some respects for being an automotive retailer. It has led to amazing financial results for the past few quarters, and we'll talk about the environment as we go forward. So the company has 65 million shares, trades at about $120. $8 billion equity cap, about 2.6x of net debt for $10.6 billion total enterprise value. And so gentlemen, thank you very much for joining me and my colleagues today. And with that, we will go right into Q&A.

Brian, thanks for the introduction. And if you don't mind, I'll just make a couple of quick comments.

Oh, please. Yes.

It's okay. No, I'll make a couple of quick comments just to kind of level set. We got a little bit of time here and just to kind of put the whole thing in perspective. I've talked about the business, and our business is far simpler than the presentation I just saw on lithium. Ours is pretty simple, right? It comes down to 3 things right now. It's how you respond to this remarkable demand for vehicles, whether it's new or used? How you use your digital capabilities, both externally and internally, to drive sales and drive efficiency, and then how do you redeploy capital? Very simple. And to me, actions speak louder than words, so I can talk about this. But I think if you just look at our Q3 results, which we announced 2 weeks ago, I think it demonstrates how we're actually living these every day and, frankly, doing better than our peers in all categories. So real quickly start with revenue. So revenue was up -- for the quarter was up 18% year-over-year. That was driven by used units, up 20% versus 2020, 22% versus 2019, right? So we've talked about how we have a very successful strategy of in-sourcing vehicles through trades and our proprietary. We'll buy your car program, coupled with our expansion of AN USA, is driving above industry average growth for the top line. You go to gross profit, gross profit is all about how you more effectively are selling the inventory that you have. Our new vehicle -- our used vehicle, our CFS, which is our F&I, PVRs were all up year-over-year across categories with total variable PVR up 39% year-over-year. That is all about how we're using our digital capabilities to more effectively sell in service vehicles with the fewer employees. Then you go down to operating income. Operating income was up 63%, with SG&A as a percentage of gross at 56.9%, a 750 basis point improvement year-over-year. This is all about cost and how you drive SG&A lower. This is about how we're doing the same business with 3,000 fewer associates in our store and leveraging our back office, our shared service center in Dallas. Go down to the bottom line, EPS of $5.12 for the third quarter. This is more in 1 quarter than we generated in all of 2019, which was then a record, right? That's up 115% year-over-year. It's -- frankly, it's more than double the growth of our peers, and that's driven in large part by very effective capital redeployment. As you know, we've spent over $2.2 billion over the last 12 months repurchasing shares to reduce our share count by 27%. So very simplistically, I think about our business, revenue up 18%, gross profit up 31%, adjusted operating income up 63%, EPS up 115%. And that to me in the most simplistic way to sitting on all cylinders, and that's the strategy that we're executing. So with that, Brian, just as a setup, why don't we jump into the Q&A?

Yes. No, that's an amazing setup, and it also speaks to maybe we'll stay down just this environment. Some may look at your quarter and think that it's a bit of a moment in time quarter given what's going on with new vehicle inventory. But I think that there's a lot more here. You mentioned 3,000 fewer associates. So maybe talk about how your business is structured on a go-forward basis to be just structurally more profitable than it was in the past? And what that -- what do you think that means for shareholders?

Yes. I love your moment in time, Brian. So this is 6 consecutive quarters of record profitability. So at least it's 6 moments in time.

It's a long moment.

Yes. It's a long moment. A very good moment for me. No, but you hit on a critical point. So if you go back really pre-COVID, and frankly, when I arrived in early January of 2020, we had some pretty ambitious goals of how we thought the business could operate going forward more efficiently, more effectively. All those plans were put on acceleration in the midst of COVID. As I said, you never let a good crisis go to waste. So what did we do? We dramatically reduced headcount. We deployed the digital tools that we have within the stores, within our back office. We really slashed discretionary spend, and we looked at lines of business that were less profitable and focused on our core. And so if you look at that, as I said, we're operating today with 3,000 fewer associates on a same-store basis within our stores. We've deployed digital tools that enable our sales and service associates to operate more effectively. We're continuing to deploy more technology to allow our back offices to operate more seamlessly and more efficiently. And so in an environment of incredible demand, and demand that we see continuing and, frankly, pent up because of the shortage of new vehicles, it's really about how you're being disciplined with your cost. You're being very thoughtful about how you deploy your inventory and then how you redeploy your capital. So those dynamics are in place for a reasonable future. The situation is very unlikely to change in the near or immediate term because I do believe the demand is going to continue based upon just people's fundamental desire to have personal mobility fueled by attractive interest rates. And you're going to have a shortage of new vehicles on a relative basis for some considerable amount of time. That's obviously well documented in the press. And from where I sit, I'm a very simple person. I look up and I say, we're not meeting demand, let alone building inventory at this point in time. So the first thing is just we're selling every vehicle that's effectively shipped to us. And that's going to continue for some period of time before we're able to actually build inventory. So again, not a moment in time, but I think we're going to have several more moments before it's all said and done.

Very well said and excellent job dispelling this -- the idea of the moment. Mike Jackson has spoken to this idea as well that your OEMs have realized that with production discipline comes margins that are truly worthy of the amount of CapEx and R&D that they put into each of their platforms. And that in turn has had a positive effect on what you and the rest of your retailing peers do. Talk about what this discipline from an inventory level could mean for AutoNation and also the broader dealer ecosystem for the long term, if this holds?

Yes. So -- and I appreciate the question. So Brian, Mike is great at storytelling and has told me a lot of stories over his distinguished career and talked a lot about how in the past the push model, which obviously was driven by the OEMs, pushing tremendous amounts of volume into the system, was viewed as flawed. But there was never a test of that, that anyone could reasonably execute. You couldn't go off on your own and execute it. What COVID did is demonstrated to the whole world that you could operate with a completely different model from a inventory management standpoint. And so what, I think, the OEMs have seen -- and I don't want to speak on their behalf. What they've seen is by operating at more moderate production levels, they're able to generate more profit per vehicle. And you don't need to have 90-plus days of inventory sitting on all these lots to accomplish that. I think there's 2 parts to the answer. I think in the short term and the short to medium term is measured in quarters, not months. We're going to be in this environment because there just is not the ability to produce fast enough to meet demand and build supply. So in one breath, is that 4 quarters, is it 6 quarters? It's a number of quarters before the inventory can realistically build. That said, I do believe, and there's enough anecdotal evidence to support it, that many of the OEMs have kind of, if you will, got the joke. And that there is a much more profitable way to operate their businesses. And I think there will be some resilience and resistance in racing back to a model that just ramps production beyond demand and suffers with significant inventory, which results in significant incentives. And I mean I do believe there will be some period of time. Unfortunately, we all know memories are shorter than we'd like. I think for the foreseeable future, we're going to be in this type of environment for those 2 contributing factors.

I would agree and remain hopeful that this lasts longer than what will eventually be competed away. Before COVID began, one of the exciting stories about AutoNation was the rollout of its AutoNation used car superstores. And I think that given the operating environment, it's almost taken a bit of a backseat to what you're doing from a profitability standpoint. But you're accelerating there, and it's a strategy that's working. Can you talk about this used car superstore rollout? Where you are? Some of the metrics that you gave on the last call and how impactful this could be for your business as you move forward?

Sure. So when I arrived -- just a little history. When I arrived in early 2020, I walked in and we just were talking about the learnings, if you will, of these 5 pilots we had in AutoNation USA and a plan to accelerate that. That got put on a temporary -- very temporary pause as COVID hit. And as soon as we saw daylight on the backside of early COVID, we said we need to accelerate this strategy because it has tremendous potential. And so we looked based on what we learned through 5 different pilots as to what is the optimal model. We set ourselves on that model, and we committed to roll out 5 stores this year, 12 stores next year and really get to at least 130 stores by the end of 2026. That model was basically a much smaller scale version of some earlier stores. So kind of a $10 million to $11 million equity investment or investment into the business. And then an operating model that we thought could generate $200,000 a month at full run rate. We thought that would take 12, 18 months to get to. What we've realized in this environment, the demand is there, the model is correct and provided we can effectively source the vehicles, which has been one of our critical differentiators, the success is far exceeded our own expectations. So the stores that we have opened this year all have generated a profit, if not within their first month, within the first 2 months and are continuing to track that way. We have 2 more stores that will be opening later this year. And so from our perspective, we found the model is correct. We are finding ways to actually reduce the investment modestly. And with the success of our sourcing and training, we're able to ramp these stores quicker and more profitably than we expected. And so that's surprising, we're continuing to evaluate how do we take this and move it even quicker, provided we can do it in a disciplined fashion. So we think it's got tremendous potential. It's highly complementary with the franchise model because we obviously have far greater flexibility in identifying sites, and we don't have some of the OEM restrictions. But can really use this as effectively creating a very broad distribution network that extends far beyond our franchise dealership. So we see them as going hand in glove together, both from a sourcing and distribution of vehicles, and very excited about the potential.

You all are in Fort Lauderdale, you don't know anything about gloves. We do. Staying with AutoNation USA, you're now sourcing 90% of the used vehicles you retail internally. That's exceptional. Talk about how you're becoming better buyers, how tech is enabling that transition and how Auto USA really improves that sales funnel for you.

Without giving away too many secrets, you can appreciate, this is something that has proven to be a true differentiator for us. So it really starts with some of the data searching and data sourcing that we're doing to identify the most attractive opportunities to acquire vehicles. So as much as I'd like to say that people see the ads on TV and walk in, that clearly is not alone what's driving the success. So it's how we've been able to utilize our digital tools and scrape to identify the most attractive vehicles to apply. And then how to contact and to present a compelling offer that the customer will execute. We've seen that grow now each quarter. And as I just compare Q2 to Q3, I think one of the more notable things was in both quarters, 90% of our vehicles were in-sourced as you referenced. The notable difference in my mind was in Q2, 20% of that 100% was We'll Buy Your Car. That increased to 25% in Q3 as obviously have slightly fewer trade-ins and we've continued to ramp We'll Buy Your Car quarter-over-quarter, month-over-month. And this is a clear enabler for us as we go forward with AutoNation USA. So I'm pleased with the success, committing more resources to it because we do see it as a sustainable competitive advantage. And it will probably surprise you to find out that the highest profit we realized on used vehicles is, in fact, those vehicles sourced through We'll Buy Your Car. So not only is it growing fast, it happens to also be our most profitable channel.

That's excellent color. I think maybe for those that are in the audience and that are on Zoom, can you explain the We'll Buy Your Car initiative and what that means?

Yes. So what basically We'll Buy Your Car is this initiative that we have kicked off and actually been running quite a while now. It is really we will buy your car. Whether you're trading in a car or not, it's basically our procurement of vehicles directly from customers. So it's not a trade-in. It's a direct procurement. You bring your car in -- and again, we have numerous ways to identify and solicit these vehicles. You bring a car in, we have a centralized appraisal operation. We instantly get you an appraisal and can provide you a check same day, same time to acquire your vehicle. And it's been met with resounding positive reception. It's allowed us to acquire vehicles at a very rapid pace. And as I said, it's proving to be more a profitable trade than either a trade-in or clearly wouldn't go into the auction. So it's been a relative strength and one that we want to continue to build upon.

Want to stay within the side -- this broad idea of advantages that you have that are inherent given who you are and your size. Can you talk about the omnichannel rollout? How online buying is becoming more important and how your coast-to-coast physical backbone helps enable you to not only move with the market but accelerate along that way?

Sure. Thanks. So -- and that covers a number of fronts. So I think one of the things people are realizing with omnichannel is to execute that successfully. You do need physical touch points for customers across the country. As much as people want to believe it's completely virtual, the actual delivery setup and service of a vehicle does require on-site presence. So as we've continued to elevate our digital tools, as we continue to have a broader and broader reach, with the country's largest footprint and continuing to grow with the expansion of AutoNation USA, it really does provide us a very, very economical way to continue to both source and sell vehicles, whether new or used, particularly used, on a much broader footprint. And if you look at the comparative-- it's all public data. Look at the comparative economics in particular of used vehicle across both the established retailers and the online retailers only, if you look at their profitability per vehicle, our model continues to outperform both the traditional retailers and the online through a combination of a successful sourcing, a not an overdependence on advertising and not an overdependence on distribution costs to get down to a profit per vehicle that's very, very compelling. And so we think we have a very sustainable model. We see how AutoNation USA can continue to help us spread the platform to support and service vehicles and think we have a pretty compelling value composition that is predicated on having the infrastructure in place to actually support the sale and service of vehicles. Without that, it's a very difficult economic model to sustain in this time, or God forbid, times that are less attractive. So we like the model we have. It's generating very, very strong profit and cash flow, which we think is a good business model. We're kind of old school in that regard.

Certainly. You made the decision a few years ago to move to AutoNation-branded F&I products and also AutoNation-branded parts within your fixed operations. Can you talk about where you are in that strategy, some of the benefits, both from a customer engagement perspective and also a profit perspective that you've enjoyed in that time?

Yes. So why don't we start with F&I? As you know, we call it CFS. And we did spend a considerable amount of time and money to develop a comprehensive brand of product that for the customer, all looks and feels and operates on an integrated harmonious basis. So it's not a series of completely independent offerings. It's a series of offerings that are offered as a suite and work together. They offer not something -- I mean the reason they're successful is they offer a very valuable proposition to the customers. And we've seen an increase in penetration by product. If we look at our F&I, it's industry-leading, but I think one of the things people don't understand is 2/3 of that is product, not the financing. And what we're continuing to see is a greater and greater penetration of products, which is continuing to drive that to be an industry-leading figure that has been a strength, and we believe will continue to be a strength as we continue to make more investments to ensure that we have really compelling products. And our customers want them. So that's an example of how we've used the brand to create a suite of services that also you can obviously find them really across all of our locations rather than every location having a unique and distinct offering. So...

Yes. I want to touch on 2 topics in the 8 minutes we have left. One is electrification. We have EV models set to roll out in earnest in 2022. Discuss how your dealerships are preparing both from a sales level to also the parts and service, the bays that are going to need -- that you're going to need over time for customer support.

Yes. So EVs are here to stay. We all know that. They're still going to represent a relatively small portion of the carpark really through the next decade. So while there's new entrants and clearly getting a lot of attention, we've got to be able to support and service both EVs and combustion and hybrids. So again, feel we're very well positioned for that. When it comes to the EVs, they're exciting, but they are requiring capital. So for all of our stores, you've got to make the necessary investments. It's anywhere from 100,000 to 500,000 plus per store, depends on the brand, depends on what's happening. Investment upfront, that again is going to differentiate those that can and cannot make those investments. But what we see on the backside is a further, I'll call it, bifurcation of the market as it relates to who's going to have the capabilities and technologies to service these vehicles. And while I know -- on some commentary, they say, oh, it's a simpler engine and it's less service, highly complicated batteries and battery care. And everything we've seen to date indicates the service is as or more expensive per vehicle, and we believe you're going to see fewer people capable of actually servicing these vehicles. And so while it's going to play out over the next decade or more, we think this will be another area that kind of separates the haves and have-nots in the marketplace. And while it will be a relatively small percentage of our revenue in the next couple of years, particularly from the service side, we do believe we're very well positioned to capitalize that in the long term.

Do you think that given how you're structured from a geographic standpoint that having an EV-only service location kind of centrally located within, let's say, one of your South Florida locales might make more sense from a capital standpoint? Do you think that, that's potentially a strategy and how you service that market versus dealer by dealer?

So that's a great question. It will depend on how this rolls out. As you know, most of the brands have pretty strong ideas of how they want their vehicle serviced and what their want their experience to be. And those of you that have EVs and know the challenges of getting those serviced, the notion of a centralized, even if it's regional, can be pretty frustrating. So we will continue to evaluate that. I don't think that will be the predominant model, Brian. But I think we'll all see as it evolves, just what is both -- maybe most importantly, what is the customer going to expect and require, what are the OEMs going to want and then how do we find the right middle ground to service that cost effectively.

One of the hallmarks of AutoNation has been its excellent capital allocation. Most notably, its buyback. 5 years ago, you had 100 million -- you ended the year with 100 million shares. Last year, you ended the year with 83.5 million shares, and you have 65.5 million as of September 30. Just talk about prioritization and capital allocation as you move forward with all the opportunities that are ahead.

Thanks. So I'll be concise here. But first of all, it starts with strong cash flow. It starts with a very strong balance sheet, the only investment-grade credit in the stand-alone or all retailers. So when you start there and you have significant capital to redeploy, you have to prioritize it. We prioritize it based on returns. Our highest returns have been organic, particularly AutoNation USA. And so we have prioritized capital first and foremost behind that initiative, and fully funded throughout kind of the horizon. You then get to really, I'll call it, the additional capital, and we have been looking really on a case-by-case basis at either M&A or share repurchase. And by and large, with a few exceptions, and we've announced 2 significant deals this year that are about $800 million in revenue total. But when you look on a relative basis at the value of our company versus multiples being transacted in the private market, share repurchase has been a very, very compelling opportunity for us. We've generated a staggering amounts of cash. Capital is at almost all-time low, financing costs, the combination of which has proven to be very, very compelling. We have a very strong shareholder support to use our capital opportunistically. And as you cited, and we've acquired 27% of our shares from a year ago. And going forward, we'll use the same kind of scope, filter, to ensure that AutoNation USA and other organic things are funded, look at M&A opportunistically, but it has to make both strategic and financial sense. And then particularly with where the stock is trading today, we will be opportunistic on share repurchase.

Terrific. Last one for me before maybe we take one from the audience or Zoom. You've got a universally respected incoming CEO coming in, in Mike Manley who's taking over for really an industry legend in Mike Jackson. Maybe talk about what Mike brings that will benefit AutoNation, its teammates and its shareholders as we go forward.

Well, so you referenced, I mean, Mike Manley is extremely well known and a proven leader and very effective in the automotive industry. From my perspective and our perspective, he's got the perfect complement of OEM and auto retailing background. And it's -- so yesterday, it was day 1 for Mike. So I don't think it's fair to say what are all your strategic priorities. But what I can tell you...

Yes. How's he doing so far?

Yes. So far, so good. He's up and running. What I can say is really the strategy we employed 18 months ago when all of this started and we had the transition was let's get the business operating as effectively as we can. Let's make some of the tough decisions on the portfolio. So if Mike Manley walks in, he walks into a business that has significantly reduced cost, an engine driving a used car machine, a portfolio that's been pruned down to the most profitable businesses. And an extremely strong balance sheet with strong cash flow that he can think about how he wants to take the company going forward rather than spending his time on -- as you know, for many CEOs, the first couple of years is how do I clean up the mess that I just walked into before I can hit the ground running. I'd like to think Mike is walking in knowing that we've had this record run. The run is well positioned to continue. And he now has the luxury of saying, how do I want to take this company over the next 5, 10 years, focused on that rather than how do I clean up a mess. So to be continued as far as exactly how Mike will do that, but I feel very good as part of an executive team that position the business so that we have that opportunity and Mike can hit the ground running. So stay tuned.

Well, we certainly will be. That's bumping us up on time. I want -- Joe, I want to thank you; Rob, you as well, for being with us today. I look forward to seeing you in Fort Lauderdale in the very near future, particularly when it gets cold up by us.

Always welcome, Brian.

And we will talk to you soon. You all take care.

Thanks, everybody.

Thank you.