Group 1 Automotive, Inc. (GPI) Earnings Call Transcript & Summary

Hello, everybody. I'm Adam Jonas. I head up Morgan Stanley's global auto and shared mobility team at Morgan Stanley. Really pleased to have with me joining us for this half-hour session the Group 1 team. We got Daniel McHenry, Senior Vice President and Chief Financial Officer; Pete DeLongchamps, Senior Vice President, Manufacturer Relations, Financial Services and Public Affairs; and Jason Babbitt, Senior Vice President, Manufacturer Relations, Financial Services and Public Affairs. I've got -- we got the whole team here, and I'm really looking forward to having a good discussion about Group 1 and the state of the industry. Before we do that, I just wanted to read a disclaimer that this call is for Morgan Stanley clients and appropriate employees only, not for members of the press. For important disclosures, please see the website, www.morganstanley.com/researchdisclosures. And if you have any questions, please don't hesitate to reach out to your Morgan Stanley sales representative. With that, Group 1 team, maybe Daniel and Pete, Jason, I want to give you guys a couple of minutes off the top to make any introductory remarks, emphasize any key messages for investors here.

Terrific. This is Peter DeLongchamps. I'll just speak for a moment. But I did want to make one clarification. Jason Babbitt's our Corporate Treasurer. So he...

Yes. Thank you for that, Pete.

That's okay because I don't want to do his job, and he d*** sure doesn't want to do mine.

Yes. Okay.

So anyway...

That's a long title. That's title's too long for 2 people. Maybe for you. But Treasurer's a little bit easier.

Well, it's how we work here. From an SG&A standpoint, Earl Hesterberg gives us all like 3 or 4 jobs and pays just for one. So that's how it works. But anyway -- and thanks for joining us, everybody. We have 186 dealerships worldwide, 119 in the U.S., 50 in the U.K. and 17 in Brazil. Clearly, we've been through a very interesting time, but I think we also proved the resilience of our model with our results. So 2Q results were terrific. We set an all-time record for a low SG&A. We reacted very quickly when the pandemic hit, which shows the flexibility of the model. But I think the other thing that we clearly demonstrated through all this is our ability to pivot on what we'd call traditional retailing to more of a -- to an online presence. Our Acceleride platform, we set a record last month with over 1,000 sales, 12,000 leads. So our omnichannel initiatives are really paying off. We've got a separate deck, if anybody is interested in seeing that. But we've been very successful in working with our customers how and when they want to do it. Whether it's traditional, pickup at a dealership or contactless delivery or home delivery, we've been able to to do all that. And all the while getting our parts and service business back to almost to a pre-COVID level, which, as everyone knows, the parts and service business is the key to our business at a 54% margin. That's what we really pride ourselves on. And then the F&I business continues to be industry leading. So it's been an interesting 6 to 7 months, but we've come out of this so far with a lot of success. So with that, we'll open it up back to you, Adam.

Yes. Let's go through a few things. I want to talk -- tick off a few boxes on demand, inventory use, credit, et cetera. Let's start with demand. How does demand look so far on the data you've seen in the third quarter? Anything you want to call out as rate of change, better or worse, by region, by segment? And I'd be curious, as you talk to your stores, the character of the recovery. How much of it you think is due to pent-up demand that maybe isn't to be extrapolated? Anything you worry of extrapolating here?

Hi. It's Daniel here. We aren't seeing any material differences between the markets currently. The oil markets particularly, which we have a significant presence in, we're watching very closely. However, they're still performing in line with the other markets. Certainly, the V was to be expected since the SAAR dropped below $10 million for a bit. But we are still well below COVID levels. I think it is likely that the SAAR remains at these levels for the foreseeable future until unemployment recovers significantly and we're returning -- and the return to $17 million SAAR just won't happen that quickly as long as fleet remains depressed.

Well, let's talk about that.

Hi, Adam. The...

Sorry, please.

I would just add that those are -- those comments are more specific to the U.S. market.

Yes.

Daniel, do you want to talk about the U.K. market?

Yes.

We're seeing better resilience there.

So the U.K. market is slightly different. If you look back when the pandemic hit in March, the U.K. dealerships were closed throughout April and May and reopened again on the 1st of June. At the end of March, we had about 5,000 cars that we had taken orders for that we hadn't delivered. Some of those got delivered in quarter 2, but a significant number of those have rolled into quarter 3. Traditionally in the U.K., people tend to order new cars in advance as opposed to collecting from the dealership that day, that week. So order bank has been building and building at a significant level since we reopened. I guess that the 2 months that we were closed, there's been significant pent-up demand there. And September is the second-biggest registration month in the U.K. 40% of cars get sold in March and September, and the market is proving resilient there.

Thanks, Daniel. So let's talk about dealers' stock levels. I mean a lot's been discussed about how critically low it is in some segments, particularly in full-size pickups and SUVs. How long do you expect that to normalize based on the shipments you're getting from the OEMs? You think this can get resolved within 2020? Or could the tightness kind of extend into next year?

Well, I guess the good news through all this, Adam, is that margins are up substantially through the inventory shortages. But we think it's going to normalize by end of the year, mid-fourth quarter. And we're starting to already see some pickup there. But clearly, the hot models, whether it's Toyota Tacoma or Silverado, there's still a shortage. But the OEMS, I think, have really done a tremendous job of getting things reopened, getting the supply chains reestablished. So I think this past month, we -- for every car we wholesaled, we retailed it just as quickly. So we still have clearly some days supply issues with full-size pickup trucks. But all in all, we're very pleased with the way the OEMs have responded through this.

I mean we've seen the impact on used prices has been just astonishing. Manheim seems to be setting a record every month. Curious if you could comment on your used business either on volume, GPU. And kind of -- any commentary you could offer on folks, it's good. We love our used business. But, I mean, this seems crazy, Pete. I mean how long -- when do you expect this to start normalizing? And is that really also a derivative of just the tightness of the new inventory driving people into used? Or are you really seeing, based on the conversations, like a bit more of a maybe temporary but a higher-for-longer change where people are leaving cities and this kind of urbanization trend kind of moves backward for longer than people think?

Well, first of all, Adam, you and I have been talking about this for 10 years. The collapse of the used car business has never quite happened. And -- but...

It's never happened. I've been wrong 10 years in a row.

Oh, and I didn't argue with you much. It's like all these off-lease cars kept coming. They kept coming and we just kept selling them. So -- but clearly, the demand is there for used. And when we saw April roll around and used car prices were down 15%, we were clearing the decks as fast as we could. And then a month later, we're out trying to buy as many as we can. So -- but that's all very positive. And for us, we're agnostic whether we sell a new or used car, but the used car business has remained robust. We're going to end up probably in a 30-day supply of cars, which we normally are at. And so for us, with the pricing, it's a commodity. We're turning these cars every month. So what we're focusing on is how many cars can we take in trade rather than having to go to the auction. And I think our team has done a spectacular job with that, and hopefully we'll see that at quarter-end. And you're seeing a little bit of wholesale moderation at the auctions, and that's due to the time of year where the book changes in September. But there's -- it's clear that used cars continue to be very favorable amongst the public. And what we're really pleased with is that we've been able to post some incredible results without having to go build stand-alone buildings and utilize shareholder capital to do stand-alones, and we're leveraging the physical footprints we have today. And then also, our Acceleride platform, digital platform, has been very, very helpful in improving our used car business as well, along with the Val-U-Line initiative that we launched a few years ago. So I know our strategy is a little bit different than some others', and we probably haven't got the credit we deserve within the financial community. But we think, from a return on shareholders' interest, it's been a great play for us.

Adam, I think one of the things that we've noticed in particular in the U.K. is, I guess, a lot of our dealerships are around metro areas, and people just don't want to use public transport as much as they wanted to previously be that the Tube in London or bus. So we have seen a big increase in the price point, used cars. So the cheaper used car where people are saying, I don't want to travel in time every day on the train, I'll get a used car instead, so there's been significant increase there. And I guess the other thing that needs to be taken into account is that people aren't really going on holidays at the moment, or vacation. So instead there, the miles driven is increasing. And particularly, people that perhaps didn't have a car before are looking to have a car so that they can vacation in their car as well.

Well, maybe on that last point on the -- really the pretty juicy part of your business is the aftermarket and service business that you highlighted. Are you seeing that? Like can you comment on where that business is now versus pre-COVID in terms of capacity or number of your bays that are opened up or the amount of business that's come back versus what it was before, however you want to express it, and whether that business, you think, reflects higher miles driven in the markets you're participating?

Yes. So this is Jason. The customer pay has been much more resilient. We've seen some pressure on collision, which is to be expected with miles driven being down. And then wholesale parts as well, a lot of that is driven by collision business. We've seen some weakness there. But customer pay has been pretty resilient for us. We've had some -- there's some pretty tough headwinds year-over-year with warranty. We had some pretty beneficial recalls in the recent history that we're lapping. But in general, customers are getting their cars, taken care of. They have to. There's -- in most of our markets, there's not a good public transport system as an option. And even when those options are available, like Daniel said, they're choosing to drive those -- their own cars. And really, maintaining your car is not an option to a lot of these people.

All right. I want to go back to used for a second. You mentioned a 30-day supply of used is normal. Are you back to normal? Or are you saying that you're getting back to 30 -- give me what's normal again and where you are today.

So if you look back over the last 15 years of our company, we've been at 30- to 34-day supply of cars. And I think at the end of August, we ended up right at 30. And we'll see how the quarter ends up, but we've been able to keep a decent supply of cars on the used car lots.

Okay. On credit, how would you describe the credit availability or financial institution willingness to lend today versus pre-COVID? I understand it's resilient. I guess is it fully back? Is it even better than before? Or how would you characterize it?

I would say it's consistent, Adam. The -- I've seen a few banks change some of their LTV requirements. But I will tell you that credit availability has not cost us any business whatsoever.

All right. And maybe just a final point on that. I know there were a lot of -- the captive and third parties were reaching out in March, April, even in May, extending people, furloughing payments. In some cases, forgiving payments, but mainly just stretching out, stay in your car longer, let's stretch you out in your lease. And I understand that can create some noise now as we sequentially lap that. And then we have maybe a higher number of lease returns because you're getting lease returns that would have normally come in, in April and May. Is that -- am I characterizing that right? And how is that impacting the supply of used vehicles into your lots and/or the credit quality you're seeing?

Well, there certainly were some extensions of leases, which are now starting to show back up at the dealership. And as a franchise dealer that can use certified preowned as an advantage, that's a big benefit to us. So -- and like I said before, if we do keep our days supply in that 30 to 35 and turn them on -- as a 12x turn, that protects us from any type of depreciation on these cars and keeps our cars fresh. So anytime we can, as a franchise dealer, get first crack at off-lease cars, it's a benefit to us.

All right. Let's talk about resiliency, COVID. Your business model has proven yet again to be just as incredibly resilient to economic shock. I mean you saw how well you handled it in '08, '09, and you've done it again, your ability to flex down variable and fixed costs really on display. But as we exit the crisis, how much of these costs, whether they're sales or advertising or other structural costs that you were forced to get out for -- frankly, for survival and just because you had to do it, how much of those come back on? And how much of the cost savings are permanent?

Adam, it's Daniel. A material amount of the cost reduction should be permanent, and that's mostly in compensation and advertising expense. During the lockdown, we saw how productive our reduced workforce was in April and May and have permanently adjusted the productivity targets accordingly. Near term, the expectation is that we'll be in the low mid-60s in the U.S. And for modeling purposes, we would expect 2021 to be at least 300 basis points more efficient in the U.S. versus 2019. So below 70%. Our 2021 target for the U.K. is 80%, assuming there's a favorable outcome of Brexit this year.

Okay. Thanks for that, Daniel. So maybe if I were to ask the question in a slightly different way. When your revenues get back to a level that they were pre-COVID, how much cost cutting have you taken out?

Yes. So I don't know that we've necessarily put a dollar figure to that. I think it works out to about $50 million a year. We've more been focused on the percentage of gross profit. So as Daniel said, the math we've done based on reduced advertising and employee productivity, that works out to what we believe is at least 300 basis points of SG&A. And when we did the dollar math on that, that's at least $50 million a year.

Okay.

That would be quite an amount. And that's at 2019 normalized gross profit levels.

Appreciate that. So I want to switch to some other idiosyncratic topics affecting the business and the customer. EVs, who do you think has got some of the most exciting products in EVs? I mean like every day, there's a new announcement, whether it's GM doing stuff or this morning Ford talking about making the E -- electric 150, F-150 in Rouge. Yes, do you have any comments on EV demand and whether the consumer is ready for this? Have you seen any kind of change of interest in EV into, I don't know, excitement from the consumers post COVID?

So this is Pete. So I guess the question is interesting versus technology. So the -- some of the General Motors technology is, I think, industry leading. But is it interesting is the question. And I think the Audi e-tron is spectacular and very interesting, but it's not selling particularly well. But clearly, Volkswagen, Audi, BMW has got a full lineup coming, but we're still not seeing robust demand. I mean there's interest. But in those markets that we're in, we're not seeing a high level of demand for the products, and -- which is another reason we really like our Toyota exposure, because I think the OEMs that win are the ones that are going to be able to pivot on gas, on battery electric. Toyota's putting a big bet on hydrogen coming up in the future. So the -- I think the OEM that has the ability to meet demand on their production platforms is the one that's going to win through all this because 100% electric, I don't think, is going to be able to be sustainable for some of these big companies. I mean clearly, Tesla has done a terrific job with their brand, but is there enough demand out there for everybody is, I think, the big question.

And Adam, let me -- and maybe I'm preempting your next question here, but let me add on to this because what we really get asked about a lot related to EVs is how does this impact our business, particularly parts and service? And what we've seen -- I mean, granted it's limited because if you're talking about full BEVs, we don't sell that many of them. So the Nissan, Chevy, BMW has a couple. But in that dataset that we've researched that we sold, what we found is while those vehicles aren't coming back to our service departments quite as much, I mean, it's close, but they're coming back as much, the average repair order cost is higher. I think you'll -- so in short, I don't think we're really worried on the parts and service side that this is going to have any sort of detrimental impact to us. I think what it will do is a continuation of what we've seen over the past 10 years or even longer, is that those franchise dealers are going to continue to capture market share as vehicles become more complex. And I think BEVs fall into some of that complexity.

All right. So let me unpack that. So you're saying that returning to dealership -- and again, it's early days and it's not a ton of volume. So let's get that on the table. But based on what you've seen, they come into service almost as much, and the repair bill is noticeably higher. And so am I to read from that, that EVs are actually a more expensive cost of ownership from a service standpoint? They are more expensive to service?

That is what we've seen in our data. Obviously, as we -- caveat is that's a small sample size, but yes, that is what we've seen in our data. And I -- let me clarify. I don't know that they're more expensive. I would point to something -- we've done research on events. They look at the Nissan Leaf versus Toyota Corolla. And that's kind of a fair comparison that we've looked at. The total 5-year cost of ownership between the 2 -- and just looking at the maintenance, not insurance, gas, all that.

Yes.

Just looking at the maintenance cost of 5 years of ownership, it's pretty similar. So I don't think our results are that far off from what others are experiencing.

Okay. That's cool. So I want to talk about the startups. Which of the startups on the EV side -- because I don't really think there's many startups in the ICE side, let's just -- let's be honest there. But which of them have gotten your attention? And the reason why I'm asking is because the topic of dealer distribution -- distribution of product is kind of like the elephant in the room. I mean you've got all sorts of people who raise billions of dollars. They got a slick PowerPoint, spreadsheet, even have a plant. They do deals with GM or other folks. Some don't. And you're like, how are you going to sell these things? And their answer is like, don't ask me. All right, well, someone's going to do it, right? And they -- Elon has shown, and I think he's done it controversially, let's say, but he's -- he did the hard way. He did it himself. And we might agree that he could have gotten a lot better results if he went franchise model or some hybrid model, but that's just what he has done for now, right? How do you think those start-ups, and from your seat, can and will approach distribution? And how is Group 1 positioned to like sit across from a Lucid or a Fisker or a Nikola or a Rivian and say, hey, here's our turnkey approach. You need to have -- there is no point launching a sexy, new product and then have a shitty service. Let us help you get this -- let's do this the right way. You follow my questions? So kind of, yes, how do you see it panning out? Is there this Tesla loophole where you think -- if we're going to do their own dealers? Or you think they're going to come to you guys?

So the dealer model clearly works. And I think Elon has got an issue in front of him with service because the volumes are starting to ramp up. I can't tell you how many times the Tesla customers, who also are one of our customers, they break down. And who are they calling? They're calling us. So I think as -- and when you look at what's happened in China in the last 20 years, they went to a dealer model. And the dealer model works and -- because you need that expertise with parts and service, especially with electric. When you think about the complexity and the dangers of working on an electric car, we're investing a substantial amount of money to make sure that our shops are fully prepared to handle electric service. So you can't take an electric car to a mom-and-pop and get it fixed. And you can get the tires changed, but you've got to come to a franchise dealer. So when you see in Houston, for example, which is a big city, there's one Tesla service repair center, and it takes a long time to get your car on the shop. So if one of these companies came to us, we'd certainly listen and we'd certainly talk to them. And we could probably help, but it's got to be a good business equation for us. But I think you're absolutely right, it is the elephant in the room. Distribution, no matter what business it is, is always the most difficult thing to perfect, not to mention the financial piece of it. In today's model, when a Chevrolet comes across the line, we pay for it immediately. I mean it's on our books. Elon has -- it takes them how long before he gets paid. And I think as these things are very capital intensive, they're going to have to be -- pay quick and close attention to the cash flow, which is something that we do very well.

All right. I want to move to your favorite topic, then I'll take a couple of questions, if we have time, from the webcast. Carvana, your favorite company -- okay, maybe your favorite multiple, sorry, your favor multiple. Their market cap's $30 billion, right? And good on them. I'm thinking there's a message that the stock market is sending us, right, that the digital opportunity, in used at least and maybe in other parts of your business, is just freaking huge. And so how does Group 1 get a Carvana multiple? And if we just put the cynicism aside for a second and say, hey, look, there's some stuff they're doing that is -- that you could apply in a different way given you have different physical assets and a different ecosystem, but kind of how do you get that multiple? And what do they do that you're like, you know what, this is a great opportunity for us, too?

The pandemic has moved customers into more online transacting across many industries, and we're definitely seeing this in auto retail as well. The utilization of our Acceleride platform has roughly tripled in quarter 2 2020 versus quarter 2 2029 (sic) [ 2019 ] and allowed us to become a more efficient business. As of now, there isn't a material percentage of customers who are taking the entire transaction from start to finish online, including delivery, but it should migrate towards that and an entirely online performance over time. In August, we had over 11,600 engagements with Acceleride and over 1,000 units were sold according to our monthly records. We began utilizing Acceleride as a full customer life cycle program. We're in the process of modernizing our current life cycle process. And in the next few months, we should have a program that is much more streamlined, more targeted and more integrated with Acceleride marketing. We will also introduce an artificial intelligence into the process, which will utilize our massive database to project each customer's progression path in the life cycle using predictive analytics. These analytics will be used to send a targeted message to each customer using actionable insights and will be fully automated to effectively manage customer responses. Regarding Carvana, I don't think Group 1 is likely to ever achieve the kind of multiple, nor it is something that we think is even remotely sustainable for them. We are not going to target revenue growth for the sake of hoping to achieve a higher stock multiple. We will continue to be disciplined as it relates to balancing organic and inorganic revenue and profit growth as well as returns on invested capital.

So -- and Adam, this is Pete. And I think if you take a look at the platform we have in place, whether -- and we look at omnichannel as any touch point a customer may have. And as you know, we opened up a service call center 10 years ago, and we're answering -- pre-COVID, we were entering 7,000 calls a day and converting half of those into service appointments. 30% of our service appointments now are handled through a mobile app. And so the customers have a way to digitally communicate with us however they like. And I will boldly say that the platform that we have in place is up to or better than any other online retailer, whether it's Carvana or Vroom and -- or our competitors with AutoNation, and we have a very solid platform in place. I think that -- I think we maybe not have -- have not done a good enough job messaging it, but our customers are certainly utilizing it. And we can be online retailers, and we're seeing it be very successful.

Or just carve that thing out and get $10 billion in the bank, baby. Come on. What are you waiting for? All right. No, I appreciate that detailed response and the messaging there. And I also want to thank Daniel, Pete, Jason who is not Senior Vice President of Manufacturer Relations, Financial Services and Public Affairs nor does he want to be. No disrespect, Pete. But anyway, thanks to all 3 of you for your time. And we're going to end the webcast now except for me to say, Daniel, Pete and Jason, stay safe and thanks again. And next year, actually, let's go to California, okay?

We'll see you there.

We look forward to it.

Yes. It's really going to -- take care, everybody.