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

Yes. I mean it's a critical business for us. And when you look at used First of all, we're uniquely positioned when it comes to selling used vehicles. We have a source of supply, which is trade-ins that not a lot of used only players can take advantage of. And that's generally 50% or more of the volume comes from trade. So we're excited to continue to be able to drive that. Of course, with the new volumes, the way they are. You have marginally less in terms of the volume of trades coming through. We also have an active -- we [indiscernible] program, which also is probably 30%, 40% of the volume. And then for the remainder, it comes off lease and we'll go to the auction to the extent we need to it. So I think if you talk about being able to get inventory, I think we have a unique positioning, we continue to leverage that. I think you're right regarding the different price points. I think the -- if you look at it from a more expensive vehicle, anything over 40,000, we considered on the used side to be on the higher price side. The volumes have been great for us. I mean second quarter, I think we were mid-single digits, like 4%, 5% unit growth and it's our most profitable segment from a use perspective. So that has been playing out well. If you go to the other end of the scale vehicles that are $20,000 and less, that is our highest turn segment. We turn those probably 12, 13 times a year. So you kind of always get a reset of your inventory position, your pricing, your cost position and so forth. And I'd say there is a challenge in acquiring those vehicles. And as a consequence, we've been down more pronounced than -- it certainly isn't growth, but it's -- the declines year-over-year really are a reflection of the ability to acquire those vehicles. We have a concerted effort and made some inventory corrections to enable us to be in a position to acquire more of those lower-priced vehicles. And with the turn activity that they have, I think it's going to put us in a pretty strong position. The other thing I appreciate on used is that we have vehicles that we acquire either through trade or we buy a car that end up in retail and for sale, and sometimes we -- they retail out and sometimes they age out, and we'll need to auction those. We've seen growth in our inventory levels. We probably had more of the higher-priced vehicles than we needed to support that growth and less of the lower price. And so we've been a little bit more active on the wholesale side, particularly this quarter. And so we've seen more of our vehicles go -- come out of the system from a wholesale basis, not necessarily a profitable exit for us because of the -- you don't get the CFS and finance and insurance products on it, and it's typically a negative margin. As we -- as our inventory levels and now corrected into September, we feel pretty good about where we are heading into the fourth quarter, but there were some modifications on used, again, to reflect the conditions. And I think the affordability conditions were a contributor to where you see the volume growth and so forth. So anyway, that's the way we're we're looking at the used again, the investment in technology that I referred to earlier is helping us to be a better operator on the used side, whether it's the customer experience itself, or the way we manage -- where the inventory is placed, how much we pay for it, how much conditioning, reconditioning we put into it. The technology is a huge differentiator there. The unit profitability on use has been nice. It's been steady. I think mix has helped us. But I think we're also smarter about the way we're acquiring and what we're -- how we're pricing trading, how we're pricing, we buy your car activity, we're smarter and have more information on how much reconditioning to put into a vehicle how much of it is really going to create more value, how much of it is not going to create value. And you really stick to where you have value creation on reconditioning. And then being smart about pricing, what's going on in the market, and moving the vehicles with speed. I think time is a killer when you have a big investment in inventory. So we need to be smart about pricing. The beauty of the business though, as I said, is it's a high-turning business. It turns 10, 11x in totality.

And you have a lot of unique data that you can price on?

The data is -- I mean, between our own systems and what we know in the marketplace and there's tons of sources, you have daily, hourly, even up to the minute activity on any vehicle you want in terms of mileage and brand and model and pricing levels that are there.

And before we get into the CFS and AutoNation Finance, is there anything that you're doing or implementing with AI new today that you couldn't do a year ago?

Yes, for sure. Everybody talks about how it's making their business more productive. For us, we look for tangible impacts of AI. And where we've seen it the most is on the customer service side, whether it's call handling in our business development centers, where we have either inbound or outbound calls for on the service side as an example. -- whether it's appointment making or parts availability, other things like that. An Finance, which I know we'll talk about, the the collections outbound collections activity, we've got a lot of AI-based technology there, and it's helping us. And the third area I'd point out is in our back office. We have centralized a significant amount of activity that had once been in the dealerships, whether it's billing or payable, paying your vendors, keeping your books -- and we've always used robotic technology in that space. But the advent of AI has enabled us to take that a step further and drive further automation. So I'm excited about the impact that it can have in all 3 of those areas, and there's probably a lot more that we're scratching the surface on.

Absolutely. So going into the finance side, can you talk a little bit about CFS versus AN Finance? How do you think about are there trade-offs there?

Yes. Yes. So just to touch on CFS for a second. I said it's a component of that 80% of our profitability. It's probably 30% of our overall profitability comes from CFS which is financial services products. It's -- 2/3 of the offerings are actually product protection type things. Think of extended warranties, think of appearance protection, tire protection and so forth and 1/3 of it is financing products. So think of the loan itself. The margin on the business is 100% because we're basically -- it's a commission-based model. So we have third-party providers that stand behind the products that we sell are third-party financing. I'll talk about AutoNation finance in a second, how they play into that. But it's another example of hidden inside this business that we have is 100% gross margin business on top of 50% service gross margin business, it's really attractive. And again, the cash flow aspects are really good. When you look at AutoNation Finance, we realized a couple of years ago and Mike really has led the charge for us on this is that we have an opportunity to maintain that and even leverage better the relationship with our customers. We have 11 million to 12 million customers in our customer database. But we have now been able to develop another 70,000 within 2 years of customers that we have the direct lending relationship with. And for us, you probably -- if you've not seen our financials, the growth in AutoNation Finance has been really strong. They finance now roughly 1% of all vehicles that are financed in AutoNation. So we're up to roughly 18%. We think that that number continues to go north. The portfolio now is approaching $3 billion. I think it will double in 2 years if we continue to drive up that penetration rate. the profitability speaks for itself, and we disclose it every single quarter. But I think in the second quarter, we were probably $10 million, $11 million of operating income where the year before, we were probably $1 million or less. So it's -- that profit trajectory is going to continue for us. Over the life of a loan, and AutoNation finance loan will be 2 or 3x more profitable than if we had just stuck with the traditional model of third-party lender. But we need -- we value our relationships with our third-party lenders. It's an important part of reaching the customer base that we want to reach. And I think your question on the interplay between CFS and AutoNation plans is an interesting 1 because if you're moving from, as I said, 1/3 of your CFS volume is financing, -- and if that -- if you're moving from 100% third parties on that and AutoNation Finance is coming into play a little bit, you get less of that upfront commission and you're trading it off for having an asset in a portfolio that gives you that value over time as said it's 2 to 3x. It does have an upfront drag on CFS. We've talked about that extensively. And I think it's something that is a long-term economic decision. It's superior for our shareowners. So we're -- we'll continue on that trajectory. We'll continue the growth path. In terms of current performance, I think AutoNation Finance is doing wonderful, and it's managed. It's interest margin very nicely in a not easy environment. we've got pretty good match funding between fixed loan portfolio receivables and the type -- the way we finance it. We've gotten really good support from the markets in terms of the ABS activity. And we've gone out to finance the portfolio. We've done 3 ABS transactions now, and it has been -- it has a meaningful impact on our cost of funds and supporting the growth in that portfolio. So all that is working well. CFS also on its own, we judge it by both the volume growth, and that's totally dependent upon the number of vehicles we sell, and it's unit profitability, which is dependent upon the number of products that we sell -- attach the products. Now our attachment rates, I think, in July and August seasonally come down and then they'll typically spike in September. We've seen a little bit more of a of that moderation in July and August. But I think we've come back to really strong attachment rates so far here in September. But I do expect that if you look sequentially, you'll probably see $50 to $100 impact on unit profitability on CFS before we kind of -- if you look at the run rate for September, I think we're back to normal levels.

I want to switch gears a little bit and talk about capital allocation stock repurchases, M&A? How do you balance the two? And how do you think about the types of dealerships you might want to acquire?

Yes. Great question. And the beauty of capital allocation is that we generate a lot of cash. And for the reasons I talked about earlier, the speed at which we get paid, the limited investment we have to make in our working capital. And so you have a significant amount of cash. There is a compulsory amount of CapEx that we have to spend to maintain our dealerships, call it, $300 million a year, $250 million, $300 million. And that's really driven by the OEM relationship. They'll always want to keep their storefronts up to date they want to have the latest gen model. And so every 4 or 5 years, you end up replacing a number of your dealerships, which is healthy and it makes the experience for the customers strong. And so we'll continue to do that, but that leaves a significant amount of cash to either deploy in M&A or return to our shareholders. And for us, M&A is very much an opportunistic opportunity or opportunistic endeavor, I would say. The -- our focus is on acquiring dealerships in spaces that we have a good footprint. So if you think of where we are geographically, I think of the Sunbelt, and I use the West and East Coast a bit and then if you look at our footprint, 65%, 70% of it is in California, Texas and Florida. And so if we can acquire in those areas, we have a lot better chance of generating synergies. And we can go through all the types of synergies that get. But basically, when you have a footprint, you can drive more operating synergies in examples would be reconditioning, instead of having -- investing in the capital and the operating cost of reconditioning for a dealership, you can do it for the dealerships that are in the area. You used vehicle inventory. Instead of buying for 1 dealership you can buy for an area, and you can move vehicles around depending upon where they belong. So it's our decisions on M&A and there are plenty of opportunities. We are in every single transaction you hear of. We get a chance, and we look at it from a return. Can we get the return that we require. And if we can, we'll pass. And I think we've been disciplined. This year, we've deployed a fair amount of capital. We're excited about the acquisitions that we've done and in California and on the East Coast, great attractive brands. And so far, they're performing exactly how we had modeled them. But the other attractive part is that we've continued to deploy capital in the share repurchase. We're not going to be a dividend company for reasons we came into. But really, the returning to shareowners, returning to capital to shareholders has been a hallmark of our capital allocation. So being judicial with how we spend on M&A and turning the residual to our shareholders. I think of it as every penny of operating cash flow I generate. I mean they're going to put into CapEx or I'm going to do acquisitions or I'm going to return it to shareholders. I'm not trying to build a cash stockpile, happy with our leverage levels although we continue to monitor that, we are the only investment-grade rated public dealership. That's important to us. So we'll continue to manage that as part of the equation.

That's great. Derek, any thoughts on nuance for the quarter or for models we should be thinking about?

No, I think just a lot of continuation of what we've seen from standpoint, Tom mentioned a little bit of softness on the product side of things for CFS. And on the new side, it's affordability. We're seeing sales are tracking well on the retail side of things, but we're down versus some tough comps last year. Fourth quarter should see more of a seasonal swing that we would get because you had some pull ahead last year that impacted the premium luxury side of things. And margins are coming down a little bit. You'd expect that they would be coming down in the third quarter just because you have model year changeover. But we're having to meet the customer where they are and give a little bit more on price. So we can be down about 10% or so sequentially on GPUs, but we should have that typical pickup as we roll into the fourth quarter here for now.

And last, lightning round EVs, hybrids, extended-range EVs. Is that something consumers want? Are we at the trough? What do people think about for next year?

Yes I think the incentives were really important. And we saw last year when the -- with the expiry, it just drove plethora of activity. And I think without knowing those incentives, we're seeing significant moderation on EVs. It was probably 1% to 8%, 9% of our volume, and it's come down to low single digits. I think the used EVs are still attractive. And I think that tells me that consumers are interested in the experience. But I think without -- I'm not a technical expert, but the limitations that have been there need to be addressed. And I think we're well positioned. I mean the OEMs that we're dealing with -- each have a different weighting of products that they're developing, but we'll be positioned to support that. If if the trends do improve and becomes a higher weighting.

Right. Thank you both for joining us.

All right, Daniela. Thank you very much.