Penske Automotive Group, Inc. (PAG) Earnings Call Transcript & Summary

So Penske Automotive Group is our next company. We're very lucky to have Tony Pordon here with us, and we'll get into some Q&A in just a minute here. But Penske Automotive Group, which is a Bloomfield Hills, Michigan-based diversified international transportation services company, that's a mouthful, but it really speaks to the amount of really great businesses this company has under its umbrella. It's the second-largest automotive retailer in the U.S. It's the largest luxury vehicle dealer in the U.K.; has over 25 stand-alone medium heavy-duty truck dealerships in the U.S. and Canada; is growing a significant used-only super store base in the U.S. and U.K.; has an engine distribution and repair business in Australia; and also, by the way, owns just under 29% of Penske Truck Leasing, which is a business that you'd find very few going as well as that is right now. The company has about 80 million shares, actually fewer now; trades at approximately $105 in the book; $8.4 billion equity cap. There's about $1.2 billion of net debt and on a mark-to-model basis, and these numbers are incredibly conservative. Its ownership in PTL was worth about $1.25 billion. I think that number is significantly higher now if you were to try and sell another piece of that business. So about an $8.5 billion total enterprise value company. And so once again, we're lucky to have Tony here with us. Tony handles a tremendous amount for PAG and is best known for being its Executive Vice President of Investor Relations and Corporate Development. So Tony, thank you very much for being here.

You're welcome, Brian. Thank you for inviting me, as usual. Mario, thank you as well for having me back. So I appreciate the time and to meet everybody and have a chance to talk a little bit about our business. As Brian said, we are a diversified international transportation services company, and he did a great job of laying out the different pieces that are part of our business. I think that's what makes us unique and significant in terms of the truck business not only that we own but the Penske Truck Leasing business, which is effectively called Penske Transportation Solutions at the corporate level that we have the 29% ownership interest in. When you look at our business overall, about 35% of our profitability comes from the trucking side, 65% from the automotive side. And when you look at the latest quarter that we just published last week, it was the single biggest and best quarter that we've ever had in the history of our company. We had a 53% increase in EBT, about a 43% increase in earnings per share. We beat The Street by 26%. When you look at the first 9 months of the year, we generated about $1.2 billion in EBT and generated cash flow from operations of over $1.3 billion. We've taken those funds, and we focused on the balance sheet during the pandemic. We've actually taken over $900 million out of our debt and did some refinancings of some existing senior subordinated debt to lengthen our maturities at lower rates. We've taken out somewhere in the neighborhood of $30 million, $35 million in interest expense to drive the business forward. And when you think about that debt pay-down versus the EBITDA that we're generating now, we're about 0.9x to 1 when you think about debt to EBITDA. So we're very, very pleased with that. And in terms of what we've been doing with the cash flow that we've generated, we're going to make over $1 billion of acquisitions this year of revenue. Again, we've paid down $900 million in debt since 2019, but $250 million of that is this year. We repurchased 2.5 million shares this year, and we've probably spent somewhere in the neighborhood of $100 million in CapEx. So we're doing a lot of great things to manage and grow the business and move it forward in this environment. So with that, Brian, I'll turn it over to you just to -- I know you've got some questions for me, but it was just a quick little commercial that lets you know what the latest was on the business for everybody.

I appreciate that tremendously. I want to get to the new and the -- the new franchises in a moment because I think that what's going on there is kind of a unique moment in time thing. But from a strategic perspective, I want to talk about used cars because this was a focus a year ago and it has even maybe accelerated here. The CarShop supercenter opportunity. You're pursuing used-only stores similar to a lot of your larger peers. Yours is unique in that there's a service component. So maybe update us on the strategy, talk about why service is such a critical component to what you're doing relative to maybe some others that are more just within the re-retailing of used vehicles, and then we can go from there.

Sure. First, let me set the stage. Does everybody know about the size of the used vehicle market in the U.S. and the U.K. and just how big that it is?

I didn't say it in my slides, so go ahead.

So the used vehicle market in the U.S. will be somewhere between 40 million and 42 million units this year. That's going to be 2.5, 3x the size of the new vehicle market. If you assume the new vehicle market will be 15 million to 17 million in the U.K., it's probably about 4x the size of the new vehicle market. So that gives us a tremendous amount of opportunity to tackle, what I would call, an underserved market by dealers historically. What we're trying to do is to go after that market that would be the corner lot, the corner dealer, the local mom-and-pop that has 10, 20, 30 cars on their lot. And I always laugh when I think about it. It's the guys that go on TV, and they're screaming at you because they've got the best car deals. They're wearing costumes and capes and flying around. We're trying to go after that business. And it really started back in 2008 when we went into the recession. People weren't buying new cars. They were looking for affordable transportation. So we started revolutionizing our business back then and going after more and more used cars. Today, when you look at it, we actually sell more used cars as a company than we do new vehicles. Now as Brian pointed out, over the last couple of years, we have been focusing on this used vehicle what I would call, supercenter concept. We've made 3 acquisitions. The first one was in 2017 in the U.S. We bought a business called CarSense that operates out of New Jersey and Pennsylvania locations. Later that year, we went to the U.K. and bought a business called CarShop that operated, I think it was 6 or 7 locations throughout the northern part of the U.K. And then in 2018, we bought a business called CarPeople, again, all-used supercenters that operated south of London. We then took those U.K. businesses and combined them together into one brand called CarShop and have been expanding that. And then in March of this year, we brought that brand to the U.S., and now we have one consolidated entity called CarShop that's all branded the same way. And we are looking at taking that business from where it is today, which is probably doing somewhere in the neighborhood of, I would say, 75,000 units if you look at the last 2 quarters on an average basis. And where it's going to go at the end of '23, we think it will be 150,000 units. Revenue is going to grow from $1 billion to $1.5 billion to $2.5 billion to $3 billion, and our income that we're targeting is $100 million just in that business alone. Today, it's probably running 12 -- $10 million to $12 million a quarter. So that's what makes it so unique and special to us, and this is all used cars. And then we think that adding to that a service component, there's a reason why somebody doesn't come to the dealership. There's a reason why somebody wants to buy this 1 to 4, 1- to 6-year-old used car from somebody that is a more reputable dealer. We think that they will actually service from us as well. And right now, that part of the business is only 1%, 1.5% of the used -- of the revenue in the used supercenters. And if we can take that and just double it and then work on tripling it and get it up to even 1/2 of what we see in the franchise business, which is about 10% of revenue from service and parts, it's just going to increase the profitability dramatically in the overall business.

Staying within the used space and even talking about maybe some of your franchise or your franchise operations, how much are you integrating the omnichannel experience and the online car buying into what you're doing at the used only and then transition that into the new and used because there are some different aspects there?

Yes. So it's a really good question. It's a little different from market-to-market, if you will. And then when you look at just pure EV sales -- or not EV, but just pure online sales as a part of the overall sale in the used vehicle business. I would say, today, the business that we have is probably 80% digital marketing and 20% traditional. But if you look at the focus on the traditional marketing, it's going to be in areas where we're putting the new stores in place and creating awareness. You're going to have to run billboards. You're going to have to run typical promotions. You're going to have to run television ads in those places to show that things just opened. And then we're doing a really, really good job of growing on Instagram And Twitter and any social media channels to try to push the omnichannel forward. If you look at just in terms of overall unit sales that are done online, you're probably seeing 4% to 5% or so in the U.S., which are just total online sales. And when you look at the U.K., I think they're a little more advanced than we are with respect to that business. They're probably running more like 20% of their sales that are just on online.

So it's an opportunity that you see the capital to invest. It's a competitive advantage, I would imagine.

Yes, it is. And in the U.K., for example, we offer a vehicle that can go on hold for 3 days for a GBP 99 reservation fee. And we have found that the people that make that reservation fee, a preponderance of them will actually follow through with the transaction. So if we can get them to make that reservation fee, it's going to turn into a sale for us. We haven't attempted that in the U.S. yet. We're focusing more on growth of store count and spreading out. I mean, from that, I mentioned that we were in New Jersey and Pennsylvania initially. We just opened last week our first service store. And we've got a few other markets that are playing for the U.S. as well. But it is like a big-box store out in Scottsdale, which is the fifth largest market in the U.S. So we'll see how it goes.

There's so much going on with your new franchises. I'm going to pivot away just for a second and talk about the commercial truck dealerships, Premier Truck Group. You're at about 25 now. Where do you see this business in 5 years? And at what point, just thinking about financial engineering here, can it stand on its own like a Rush?

Yes. I think it can. We have been growing that business. It's more than doubled since we bought it in '14. So we -- unlike Rush, who represents a bunch of different brands, we represent the Freightliner and Western Star brands in our business, and we're exclusive with them. We are in the Dallas market if you think about where the main hub of the stores are. We've got 2 locations in Dallas. And then we float up the Central U.S. into Kansas City, Idaho, Utah. And then we've kind of straight away a little bit, we bought a big business in Toronto along the 401 that connects Detroit in the U.S. border with Toronto. And then we're down in Chattanooga and the Atlanta area with a couple of stores. We are looking at continuing to grow those stores. We went to Kansas City this year, $450 million of revenue. We're seeing multiples on those businesses somewhere in the 6x to 6.5x range where typical auto dealers probably more like 8, 9, 10x. So it's a better return on capital. And when you look at the overall service and parts content that comes from that business, we're probably generating 60% to 70% of our gross profit on the truck side through repairs and services, both warranty, customer pay, collision on the truck side somewhat. So it's very, very good. It's less capital intensive. We don't have to build these fancy dealerships and fancy showrooms. It's just a big factory, big truck box out along an interstate somewhere. So we have more deals in process. We're working with Freightliner directly on other areas of the business where we can help them succeed. They are the #1 player in the marketplace with respect to truck sales. Freightliner does like 39% of the overall U.S. market. So there's a competitive advantage there. And the difference between a truck dealership and a car dealership is if you're in a given area and you have a car dealership, you may see 3 or 4 different Toyota stores, and they're all going to be owned by somebody else, right? You're not going to dominate or have one market where you own all the stores in the marketplace. On the truck side, we own Dallas. We own Kansas City for that brand. It -- so they give you these big markets instead of just one store in a given market. So I think there's lots of opportunity still there. When you -- it's an aging dealer base. They have nobody to give these 2. They're selling those stores. So I think we can do very well there.

I agree. Just staying with M&A. On the new vehicle side, it hasn't been really a -- not that it hasn't been a focus, but it just hasn't been where you've allocated capital a ton over the course of the last several years because it's gone into used, and it's gone into PT or the Premier Truck Group. What is an optimal multiple to buy if you were looking to expand on your new dealer base?

We've done things at 5. We've done things at 10. It depends on the type of brand and if we're trying to enter into a market or we think that it's a big growth brand for us. We've got significant dealerships that we've paid up for to grow into the individual market. We just did that with Mercedes-Benz in Charlotte. We probably paid a little bit more than we wanted to, but Charlotte is a growing market. Obviously, all the race teams are in the Charlotte area, too, so it makes a lot of sense. And we paid up for that Mercedes-Benz store. But in most cases, we don't want to pay for a dealership there more than what our stock is trading at. We've got the different alternatives. And if we can buy back stock at a lower rate than it takes to invest in store, it just makes more sense to us.

For the past 14 years, you've pretty much been able to do that.

Yes. For sure.

All right. Let's talk...

And we have.

You're right. Let's talk about the environment now. There's no inventory, right?

Very little.

And talk about how you're operating in this environment, the focus on gross per vehicle and how you think when things do normalize, they'll normalize eventually, you look from a profitability perspective relative to before. My own thesis is that dealers are structurally more profitable coming out of this than they were going in.

Correct. I agree with that. We -- you really have to go back to March of last year. I think it was like March 12 when the world shut down, right? We were faced with a pretty dire situation at that time because although we were deemed essential, we didn't know what mask mandates were going to bring. We didn't know what individual State mandates were going to bring and what would stay open in a given state and what had to close. In many places, the dealership had to close or the showroom had to close, but service could remain open. So our reaction to that was to furlough 57% of our entire team, okay? We took out -- we have 23,000 employees. So you think about taking out 57% of that around the world, and it's like, wow, okay. From that, as business started returning and the economy allowed us to reopen certain places, we brought back a significant amount of people, but we kept out about 3,000 heads. So when you look at a 3,000 net decline, and today, we're still at probably a 2,000 net decline, that's a significant cost reduction. At the same time, I wasn't doing this. I was sitting at the computer talking to everybody in here, and for the most part, we're still doing that. As you know, this is one of the first ones that has happened face-to-face. So things like travel, entertainment, advertising, we cut out all those costs. And they're not going to come back at the same level anytime soon. We've taken out 1,135 basis points of SG&A to overall gross profit. And we're in the 65-ish percent of SG&A to growth right now, which is good. We think that, ultimately, we're going to end up in the low 70s. I don't know if it's 70%, 71%, 72%. That's too precise for all the moving pieces that we have. But that's going to be down long term, probably 500 basis points from where we were prepandemic. So we're operating today in a scenario where we're being more efficient, fewer people, higher grosses, and I think we're being much more effective. And that's just across the auto side. We have talked about trucks and PTS in terms of what they're doing. So I'm very happy with where we're at right now.

I think we have a Zoom question, Chris?

"What do you think about some emerging technologies in the trucking market, EV or hybrids using CNG or RNG and electric drivetrain? And then do you see demand for your customers for these innovative solutions versus ICE trucks?"

So the answer to all of that is yes. It's a really good question. Penske Truck Leasing is on the cutting edge of testing all of those different fuels and testing some EV products. We've got a pilot going on in California right now where we've got a -- just some EV trucks on the road and an EV charging station in place to see how it does. I think that when you look at whether it's pure BEV, Battery Electric Vehicle, it's a hybrid, it's any type of natural gas solution, it's propane, whether you're talking in cars or trucks, the biggest challenge we face today is infrastructure. The infrastructure in place to be able to allow people to drive these different vehicles, it just doesn't exist today. It's not like going up to a fueling station, filling up your car with gasoline in 30 seconds. Whether you have -- I mean we've -- as an auto business, we've put in 580 charging stations in the past couple of years to prepare for this, right? That's not nearly enough. Those charging stations are generally Level 2, which still takes 6 hours, 8 hours for your car to charge. Think about how you're going to do that as you're driving across the country or trying to move the car. So I think all those technologies are really good for the person on Zoom, and we're working on them. I would add that the key in the trucking business is connectivity, though. It's being able to talk to the truck and have the truck talk to the driver so that we know what's going on, preventive maintenance for the truck to tell us when something is going to go down in advance so we can get that truck in and fix it. That's the stuff that is more important right now.

Staying within EVs and -- just staying within EVs and talking about your core business here. You've got Mercedes and Audi coming out with some really attractive electric products now that customers want. Talk about how you're preparing to service these vehicles longer term as they grow, as you need to, 3 to 4 years out, really start to put some work into a vehicle before it goes off warranty and just how you're preparing as a company and the capital allocation thought there.

Yes. So first and foremost, we're looking at what all the OEMs are asking us to do. So the OEMs are asking us to help them with the infrastructure and the charging stations, as I talked about. So we're making those investments. And then selectively, we're investing in equipment by brand that is coming out over time with the vehicle. So Mercedes first. Porsche was even before that with the take-on. The thing -- I think the thing to remember when you're looking at EVs is people just think about battery electric vehicles. And when you really look at the U.S. market today, and I don't have the first 9 months numbers, I got the first 6-month numbers, that the EV market, which includes hybrids, plug-in hybrids and battery electric vehicles is 6.8% of vehicle sales. Only 2% of that is BEVs. Hybrids and plug-in hybrids are selling more than EVs are in the U.S. And when you take that over to Europe, the same thing is true. So actually, when you look at our profitability and the amount of service that we think we get, we're going to get more work on a hybrid or plug-in hybrid that's got 2 types of powertrains in it than you will on a battery electric vehicle. There's no doubt they're coming, right? They're coming. They're going to be great products. We are prepared for it or we'll continue to prepare for it with the manufacturers, but the window here or the train is really, really long with respect to BEVs.

Tony, you brought us up to date on a lot of the dynamics, and congratulations on an extraordinarily successful year.

Thank you.

If I'm ordering a car in Europe, I go to the dealer. I tell them what I want. I wait 6 months, and then I get the car. It's on discussion that...

And they put down a deposit.

Yes. They put down a deposit and the discussion of doing the same thing in the U.S. because -- rather than forcing you to absorb cars. On the other side is also the notion that some of these companies like Rivian are going direct to the consumer. How does the direct-to-consumer play out in your mind over the next end user over the next 5 or 10 years? There's also a guy that's done that. I forget his name.

Yes. Maybe Elon or something. Is that the guy? Yes. Yes. The funny thing is Elon's putting in dealerships, right? He doesn't want you to believe that, but they are putting in dealerships to help with their backlog of service and that, but they've done a great job in building their brand. So what we see right now, actually, Mario, you got a very good question, is in the U.S. side of things, it's acting more like a European model. You look at our forward sales of vehicles right now, and when I say forward sales, we're selling into the future allocation that we get of the cars from the manufacturers. It's 40% sold out at higher grosses right now, okay? And I tend to think that that's going to be sticky, if you will, instead of the OEMs throwing 500 cars on a dealership lot and somebody showing up and just wanting to buy the car that day. Customers are becoming more and more aware of this and understanding of it. And we're more profitable. The OEMs are more profitable. So I think it has a chance to work. We have to see how it goes long term, but I think it has a chance to work. In terms of some of these others going direct, I think some will be successful in certain states where they've amended laws. Others will not. And I think we have to watch how it plays out. I think longer term, it's very easy to do when your volume is very low. As your volume grows and your distribution costs become harder, you need to focus more on manufacturing and putting the right product out and then somebody else service the customer. That's where I think it will ultimately land out. In the U.S., you have these franchise laws that are in place that protect the dealer from this. So -- but some of them have been amended in certain states. So we'll just see how it plays itself out. But it's not something that concerns me because us and one other automotive retailer in the -- that operate have international presence, and we operate in those markets without state franchise laws. And everywhere we look at that, that an OEM tries to own their dealership or tries to own their distribution point, they screw it up so bad that they ask us and save it for them. The Porsche store in Germany is a great example. In the hometown of German -- of Porsche Mannheim, we own the biggest dealership. We took over their dealership. We rebuilt it, and they asked us to do that because they screwed it up so bad.

Last question here. We got about 1.5 minutes to go. Got 4/5 lines of businesses. How do you, as a company, decide where best to allocate resources? .

It's a really good question.

That's why I asked it with only 90 seconds left.

Yes. And I love that for only giving me 90 seconds. If I pause long enough, I don't to have to answer it?

5 I don't know how you only get 0.5 hour. You need 1.5 hours.

I would love to take 1.5 hours. So it is very much opportunistic. And that we throw that name around a lot, but it really is. When you sit and look at us, we will prioritize the dividend. There's a guy that looks like Mario with that silver hair and everything that likes the dividend, and he's a big shareholder. So we're going to prioritize the dividend. There's no doubt about that. We've been promoting and showing that we increase the dividend all the time. We're working on increasing the payout ratio. So that's not going away. From there, very much opportunistic in terms of seeing what we find in the marketplace and what we're able to spend for acquisitions. We're going to grow the business, but we're going to do it at a reasonable cost. We are not going to go and try to find a $3 billion or $4 billion deal and overpay for it. Just not going to do that. So that might be a cop-out in terms of the answer, but that's the way it works. That's the way we do it.

When you ask that question with 60 seconds to go, you get that answer. So...

Yes. But thank you. This has been great.

Yes. I appreciate it. It's great to see you. I'll go talk about it outside. But thank you very much for helping make this event what it is year in, year out. So...

You're welcome. Gladly, I will always be here.

Thank you, Tony. Thank you.