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

All right. Moving along -- and another -- excuse me, another pivot from a company perspective, three very different companies to start the day. AutoNation is the second largest dealership group in the U.S. with over 320 new vehicle franchises in over 240 stores. It has been one of the most remarkable capital allocation stories, at least, of that I've seen. The company has just under 37 million shares of around $200 at print last week, but $7.4 billion equity cap, $3.7 billion net debt, $11 billion to enterprise value. So it's 37 million shares. That's down from a peak of 458 million shares in 1999. So over the course of the last 7 -- over the course of the last 27 years, 26 years, just a terrific repurchaser of their own shares. We're delighted to have Jeff Butler, President of AutoNation Finance; and Derek Fiebig, VP of Investor Relations. Derek has been with us for really since he's been back at AutoNation, but a number of years; and Jeff helped kick off the company's new internal finance organization a couple of years ago. So we're glad to have them. We'll get right into some Q&A.

Jeff, can you just -- at least start with an overview of AutoNation Finance and how AutoNation decided to get into the loan origination business after being more of a third-party -- third-party agency-related business for a while?

Absolutely. Good morning, first of all, and thanks for having me. The transition of the previous CEO and the incoming CEO, present CEO, Mike Manley, who had come from Stellantis for a long period of time. He saw the value in having the ability to provide financing for the customer as part of what we refer to as our customer journey. Creates an attachment point with the customer, average loan stays on the books, call it, 2.5 years, and it's a way for us to be able to market to that customer, continue to inform the customer products and services that the company offers. As you highlighted, the retail space. We also have over 50 collision centers. We have a in U.S.A., which are a stand-alone used car retail location. So to be able to tie all of that together. The FinCo was considered to be a strategic add. And in '22, company out of Southern California called CIP Financial had been identified and negotiated the sale of CIG to AutoNation, and we have since rebranded, AutoNation Finance. CIG had been in existence for over 30 years, singly owned by one individual. I led the company operations on a day-to-day basis and have obviously legacy CIG. Prior to that, I actually worked at AutoNation for 5 years. So I had some understanding of the company and had done business with them throughout my career on the lending side. So it just seemed a natural synergy was created with that acquisition. CIG, again, over 35 years in business, largely a subprime lender through an independent network of dealerships -- used car dealerships. Since the sale and the rebrand, we've pivoted away from subprime and largely originate prime business. The infrastructure, the leadership team had come back together from previous companies that I had been involved with. So we had a level of sophistication that probably was a little bit different from a company the size of CIG at the time of sale, $300 million book. We since now have crossed over $2 billion in originations in the 3 years. Since we've closed primarily or exclusively with our dealerships, we no longer offer financing for any dealerships outside of the AutoNation network, so it's a closed loop in that respect. And have sold off a good portion of the book, all but a handful of loans have been sold from the subprime third-party originations that CIG brought with it.

And just so you can better educate the audience, the AutoNation Finance business how much of that breaks down versus with used? And how do you ever get in a situation where you're competing with captives?

So that has been a strategic discussion all the way. There's no intention for us to compete against the OEM captive. They bring value and relationships and the ability on a host of different fronts from a financial perspective that absolutely are incentives for our stores to continue to do business with those OEM captives. So to answer the initial question, about 85% of the business that we do are our used cars, and the 15% is largely displacing some of the third-party lenders that have legacy been a part of the AutoNation lender network that you alluded to earlier. So the allies, the [ cap ones ], the lenders like that is where we've captured that 15%.

Understood. So it gives us a nice foundation to discuss really the health of the consumer through your loan book. So maybe talk about on the used side, in particular, what you're seeing both in the prime and near prime areas and then potentially whatever legacy subprime loans you have to understand what's really going on from a consumer stress standpoint?

It's been a unique journey over the last 3 years. Obviously, for 10 years, had worked primarily in subprime with CIG. So you definitely see a split happening over the course of the last couple of years -- for the subprime customer has continued to face more and more pressure as things have gotten more expensive to inflation, whether it's consumer goods, product staples, whatever kind of metric you want to use, they've been stretched. I've always believed that the subprime customer lives in some level of distress regardless of economic cycles. But when basic everyday things are more expensive, that obviously puts additional pressure that hadn't been faced over the last several years prior to that. The prime customer is still very much healthy. There's still a lot of pent-up demand for sales, and we see that through the performance. When we sold, obviously, we had a subprime book that immediately, the 22 and 23 vintages across the industry from a subprime perspective weren't performing well, so to be able to divest for them. It was a huge relief. My joke internally is that I sleep a lot better at 700 than I did 600 FICO. But we've seen in that immediate time frame after our close, we did originate a small number of loans in the context of the book today that had been aligned with subprime. So we still have some of the AutoNation assets after the initial close, and we do see a difference in performance on those loans. Again, a very small percentage of our book today. Weighted average FICO on the book in our Qs and Ks, you can see is just south of 690, and that number continues to grow with every quarter of originations.

Well, you not participate at all in new subprime financing, just not an area you want to be -- in general?

My view on subprime today is my view on leasing. I want no parts of it.

Okay. Understood. So with your history in subprime, we have seen a couple of bankruptcies in -- really in the last month or two, whether it's Tricolor or [ Prime Alan ], how much of being a subprime lender is having the experience to understand the risk that comes with the book? Or is it just -- are you're looking at land mines no matter which way you cut it?

I think the first thing is obviously specific to Tricolor aside from the alleged out and out fraud, which obviously is not a normal course of business for anyone. I think the key to subprime is remaining diligent to the underwriting, and that was one of the things in the previous iteration on the predecessor of AN Finance that we were very -- always top of mind. We updated our models every year. We looked at performance. We made proactive adjustments based on where we thought the market was potentially going, but we also are very diligent in our underwriting. And it was the reason why we had a $300 million book and not a $2 billion book is because we were very content with taking the offerings that were made available to us that align with ROA returns and a diligent pattern of growth. We were never a huge proponent of just going out and gaining market share. And I think that is where subprime as an industry, typically has the headwinds that are more self-inflicted is that you start to chase a volume number and you sacrifice the credit underwriting. And ultimately, when you're in a good cycle, you can outperform that because the consumer is healthy. But as I alluded to earlier, I made mention of earlier, any time additional pressure is introduced to that consumer, it's going to show up in performance, whether it's used car values moderating back to pre-pandemic levels and the repossession is obviously having larger severity of losses on them now or the consumer, obviously, just being pressed and a little bit more constrained than he and she had been previous to the last couple of years.

So it's a $2 billion book up from $300 million. Talk about funding availability and cost. And any constraints on securitization or warehouse lines?

I smile because being a part of an IG parent, obviously, puts us in a very enviable position compared to some of our peers. So as we've moved away from subprime, as we've continued to demonstrate the ability to originate a consistent quarter-over-quarter growth in credit quality, the warehouse lenders that we have, have continued to improve the execution of our warehouse facility. So we've continued to moderate that attachment point in the warehouse facility is up. And then we've issued our first ABS deal several months ago, that attached that, call it, 98% advance rate. So a combination of the improved execution in the warehouse facilities, the availability in the ABS market, it does not -- it puts us in a position to be able -- without requiring a lot of capital from the parent. And we'll continue to moderate or monitor the ABS market, we think moving into '26 is still a very healthy environment. And what we've seen in the market there are other avenues that we could deploy with strategic partners if we wanted to execute whole loan sale through private partnerships with some of the entities that are out there. We've had those conversations. And obviously, have been reached out to for some of the other partners that execute with some of the other large automotive retailers that also have finance companies that we could obviously leverage and deploy that if we wanted to.

I guess, Derek and Jeff, with your AutoNation U.S.A. stores -- that used-only stores, how much has the availability of AutoNation Finance helped drive unit growth there relative to where you were before?

Yes. I think, Jeff, you can weight in on this, too. The real issue on the used side has been supply vehicles. And I think we've done a really nice job of acquiring vehicles internally. We get about 90% of our vehicles internally sourced between trade-ins. We'll buy your car where that's just us direct to the consumer, where we'll purchase about 100,000 cars or so a year there. It has helped. And the good thing about the AN USA is it does give us an opportunity to play to see what different things we can do on AN Finance side of things and maybe run some different plays there in terms of can we get a little more penetration on the lending side. But we've had a deep relationship with lenders. Jeff mentioned that he'd interacted with us for a number of years when he was at CIG, and we brought those lenders to the AN USA stores as well.

I just got a note -- just for the Zoom, if you can bring the microphone a little closer. Let's talk about the used market now. We had heard availability of off-lease vehicles as being a constraint yesterday. Clearly, the consumer on the use side can be challenged. What are your current thoughts on just the -- and we've certainly seen CarMax having issues relative to Carvana from a growth perspective. What are your thoughts on the current state of the used market?

I think the used market is still relatively healthy. Derek mentioned that we source 90% of our cars internally. We use a metric that Mike talks about in our quarterly calls about holding our stores accountable on a one-to-one ratio for every new car we sell, we sell the used car. The vast majority of the transactions on our new car purchases come with a trade-in. So it gives us the perfect opportunity to acquire used car inventory without having to compete at auction, which obviously has a higher cost associated with it. So with that 90% ratio, we still feel very comfortable about being able to source used cars. We'll buy your car, which is our public-facing marketing does a really great job of allowing us to talk to consumers who are in this market to sell a car without necessarily looking to buy one. And through those avenues, again, we continue to see a healthy environment. There is a difference, obviously, at different price points. I think sub-$30,000, that's a little bit more of a competitive arena than the above 30,000 used cars. I think that's where a lot of the conversation has largely been centered on that inexpensive used car does create a different environment than the above 30,000.

Go ahead, Brian.

I wanted to just follow up on Brian's question on the used car side. So if you look at the landscape right now, where you're obviously a player, there seems to be this divergence among performance on some of the companies. And -- so I guess the easy question is kind of -- is there any thought of what's going on out there. I mean if I make it more complex. I mean, you look at like a Carvana on the online-only plays, growing rapidly, seemingly taking market share, other more traditional companies seem to be struggling. So I guess what is -- what do you think is going on out there? And is there just this growing awareness on the part of the consumer to buy cars -- buy preowned cars now online?

I think that is an emerging market for sure. And I think companies that have paid attention to what the example using Carvana that you just made reference to, companies that have paid attention obviously had to make a decision how we can incorporate some of that technology and that flexibility to be able to solve for that. There's still the vast majority of the consumer. When we step back and think about it outside of a home, the vehicle is typically going to be the second largest purchase that you make in your lifetime. And there's still the vast majority of the consumer base that wants to be able to touch that car drive it and get comfortable that it is what he or she is looking for. But that -- if we just looked at it from that perspective without an open mind, to the possibility of the consumer is changing. I think that would be naive and probably set us up for failure. So we've continued to look at that. We continue to deploy technology. One of the things that Derek just alluded to, that we get to use our AN USA stores is kind of a testing ground. So we're in the process of doing some of those things now to be able to solve for what I'll refer to as an omnichannel experience where you purchase a car completely online, and solve for it, including the finance company or the financing. So the FinCo obviously gives us a strategic advantage that only one of the other big public groups has and obviously, we'll continue to solve for that. But I do think, especially the younger consumer is much more comfortable buying that car online, and we have to understand that and have -- had those conversations and made decisions to align ourselves to be more competitive against the likes of a Carvana.

Going to, I guess, more -- these are last couple of questions, more for Derek. Just on the new side, we've seen electric vehicle sales go from 8% to a real pull forward of 10% or so in September, now down to a pretty dire situation for some of the OEMs coming out and with the SAAR for the last month. How are you positioning yourself for this new demand reality for EVs?

Yes. I think if you just look at what we did, Brian, in the third quarter, we saw higher sales, and we were able to bring our inventory down. We've been running about 7% or so overall inventory. We got that down below 4% for BEVs. So we sold a lot of them in September and throughout the third quarter. Obviously, sales were a lot lower here in October as the IRA money went away. But it's one of those things. There's going to be an underlying market for BEV vehicles. It's going to be a lot lower than it had been in the last several months.

$50,000 average transaction price broadly in the marketplace. It's maybe a question for Jeff, too. Affordability, even on the new side, it continues to defy my own expectations. Talk about your thoughts on the consumer -- the new vehicle consumer and their ability to pay $750 a month plus or $780 for a new vehicle.

I think the dynamic of the consumer and the inflection with our country is really what drives that. And you think about outside of the New York City Metro area, there really is no other place that you can have public transportation be a real solution. So it just increases the necessity of the car. And I think that ultimately, with respect to the motivation or the impetus for having to have a car ultimately will drive the consumer acceptance of where the pricing goes. The other part of it is consumer-driven as well in that every article you ever -- you read about it is more convenience, more technology, more comfort, more optionality is what the consumer is telling the OEMs, they want in the vehicle. So whether it's started out as years ago, and I'm going to age myself with this with CD players. We've now moved to WiFi. We've now moved to real-time updates, the connectivity to the car and being able to communicate with the OEM and understand how that interacts with service. Those are all things that the consumer has said that he or she wants, and that obviously comes with a price. Specific to the environment we're in, we'll ultimately see how tariffs ultimately play out and drive the additional cost. But I think that's also where we see the divergence to use your word in subprime and prime. I mean the prime consumer, much healthier financially, does a better job of savings, comes to the table with more cash down, so they're more invested in the vehicle and all of those things contribute to good performance.

Jeff, just go back one giant steps to go forward. AutoNation bid on the company in the U.K. As you were looking at the financing in the U.K. Kind of give us a quick one on one just because it applies to other companies at the moment. But outside the U.K., how would you do that -- how would you do the business there? And how would you do it in the EU?

Well, we did obviously look at the deal outside of the U.S. and the U.K. We hadn't gotten far enough along that we folded in the assessment of what the FinCo, if anything would do. Obviously, there's differences in markets. I did work for a company in a previous part of my career that finance cars in Canada. And ultimately, it is a different market. We'd have to learn it, quite honestly, Mr. Gabelli. I don't -- I've never financed cars outside of the country. So it would be something that we would have to really tackle dig into. And the only thing I'll mention there is that very much like the journey that we've been on the last 3 years, it would be something that we would do ingrain ourselves slow, diligently learn the market, just the same way we've done with the creation of AutoNation Finance, and it's the reason why to go back, we haven't pushed AN USA forward even more is that we started it wanted to get performance history and then ultimately understand where we can moderate and fuel those sales, but we would do the same thing in that scenario.

Derek, on the parts and service business, Jeff just brought up a point about evolution of vehicles and connectivity. Talk about your ability as a dealer to stay connected to the customer longer to drive that consumer back to you for parts and service work where they otherwise might have gone to an independent aftermarket service provider for some reason.

I think the most important thing is making it convenient for the consumer and making it a priority. So one of the things Mike Manley did is he brought in Christian Treiber, who run -- he's President of our aftersales business. And you want to make sure it's convenient from a scheduling standpoint that when they come in, they're received well and they see the value in terms of what you're providing them. You mentioned how the average price of the vehicle has gone up. Well, that's a bigger investment. So we're going to try to sell them CFS products or F&I as most people would call it, that will protect their vehicle and lower their overall cost to the vehicle and bring them back to our dealership to service them. If you look at what we've done through 9 months of the year, we've already passed the amount of gross profit that we had pre-pandemic. So it's a growing portion of our business. Obviously, you've seen some inflation there from price on parts as well as labor. But the complexity of vehicles is significantly greater. And there's just -- for some of these things, it really isn't a defined third-party independent aftermarket yet for some of these things, and we want to keep people coming back and just recapture them more frequently.

You bring up a point I wanted to bring back to Jeff. So just talk about the trade-off in F&I and finance and insurance, the long-term trade-off between now originating the loan versus selling the F&I product right off the BEV and how that starts to work itself out over time?

Derek reminds me every quarter the headwind I create.

Yes, the near term.

Yes, the near-term headwinds. Over the life, we talk about it often. I mentioned it earlier, the weighted average life is 2.5 years on the loan that we originate. So when you look at that, first, the upfront fee we get from a third party with respect to the financing piece of the F&I, a loan that we keep internally within our buy box is 2.5x more profitable over the life of that loan than if we were to sell it to a third party at the time of sale, and that is long-term value creation for the company. But as I mentioned earlier, it also creates an opportunity as an additional touch point through the servicing of that loan with the customer to continue to leverage other products and services. So we think it has a twofold benefit, long-term value creation, but also the connectivity through the other parts of our business is to be able to retain that customer. Derek mentioned CFS or F&I, 46% of the time, our customers are leaving, they're leaving with a service contract that we've sold them. So between servicing the loan on a day-to-day basis on the AN Finance side, nearly half of our customers receiving a service contract that incentivizes them to try and we retain their servicing, we think holistically, it creates a relationship that is a benefit to the customer and to the company in the long term.

Staying with parts and service. We have seen OEMs talk about wanting to increase their touch points with the consumer. And it sounds an awful lot like at the expense of the dealer, whether it's through direct sales or otherwise. Talk about that kind of push and pull and the value that you all clearly provide that the OEMs clearly shouldn't be trying to take away.

Yes, if you look at it at our dealerships, we've got roughly 250 dealerships across the U.S. Our Bay utilization is probably 55% or so. So we've been gated by the number of technicians that we have. And it's great to say you want to do it, but you need to have the infrastructure set up to meet the consumer where they are. There are some more applications where some things can happen over the year. But some of those are pretty complex and would take a lot longer to run so that you end up putting us through at the dealership anyways. But it's one of the things that we're looking at, but it's -- we help them sell a heck of a lot of parts and make a lot of money on that, too. So it's a nice balance there.

And warranty continues to be a source of growth. Maybe talk about that and the types of claims that you're seeing now that aren't just the over-the-air software updates relative to maybe what they were?

Yes. It's -- if you look, there was -- Brian, my background is the parts supply as well as the OEM side before I came here. And the complexity of launch is just tremendous to what you have. And the OEMs had numerous launches with various powertrains. If you're doing a BEV as well as an ICE engine simultaneously, there's just more things that can go wrong. And we've seen that happen where warranty claims have gone up. For us, interestingly enough, in the third quarter, warranty was still up, but not as much. So we actually led with customer pay, which was up 10% for us. So we like to see that. Things need to be fixed. Sometimes it's an engine problem, but there's been a lot of electronic problems and things like that, that have happened, and we work with the consumer -- with the customer, with the OEM and the customer as well to get things fixed quickly. And like Tony mentioned yesterday, you need to know what the parts are and what the solution is, but continue to work through it, and it's -- we'll see where things go from here.

Yes. New gross profit per unit outside of the third quarter, which was a little bit unique with the EV sales. We've been talking here for 4 years about expectation -- street expectations about gross per unit versus reality. Talk about where you see the market trending there and relative to overall expectations?

Yes. If you look, it's come down. It's on a percentage basis of the ASP, it's about where it was pre-pandemic. And obviously, the third quarter was impacted adversely with what happened with BEVs as well as we had a lot more domestic. We break that number out. It's a lot lower GPU for us there. But it seems like we're a lot closer to where bottom is going to be, and we'll see. I should get a pickup here in the fourth quarter with the premium luxury sales being a little bit stronger, which you typically see at the holiday season. Importantly, though, if you look at our CFS number, even though Jeff's taken about $130 a copy at AN Finance on that, that number is up like $800 or $900 from where it was. And everyone's focused on the -- just the new margin, but we're picking up quite a bit there on CFS.

And one in the back there. We have time for one more.

I don't know if the right word is, but what are you seeing in terms of like fill rates with all the Ford with aluminum, -- you got the Nexperia chip crisis? Are you having difficulty getting shipments on time from the OEMs? And is it potentially grinding towards a tighter inventory environment, at least in the short term here, which may set the stage for acceptance of price because we know what happened during COVID when supply got tight and the OEMs have been eating tariffs as it stands right now. They're just kind of like is it an opportunity for them to start pushing price in the mean term?

Yes. So the Ford situation, if you look at the typical situation where you have for pickup trucks, those are you're typically about 100 days supply just because there's so many different product variants for that. We think we'll have enough inventory. They've got multiple sources for suppliers as well for that. So it's going to be bigger for the suppliers and for Ford than it will be for us on the dealer side of things. It looks like the chip thing is probably going to be resolved. And -- but if you look at our overall inventory, industry inventories, I just saw the numbers from yesterday, probably 2.8 million units. That's down from 4 million pre-pandemic. So that sets up well for us. If you've got more limited supply out there, it helps from a margin standpoint.

Great. Jeff, Derek, thank you very much. We're got to move it along. My apologies to you for only book in 30 minutes. We'll get you for 45 next year maybe. But thank you very much, everybody.