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

All right. Moving along, another great privilege to have Tony Pordon back from Penske Automotive Group, one of the most unique companies within the automotive and vehicle space. The company has 66 million shares, trades around $160, about $10.7 billion equity cap, has $1.5 billion on net debt and also owns 28.9% of Penske Transportation Solutions. Total enterprise value is in the $10 billion range. Apart from being one of the largest dealership groups in the country, Penske has also grown and is now one of the largest commercial vehicle dealership groups and has a host of other businesses that we'll talk about. My one mistake was not booking Tony for longer than 30 minutes. So we're going to get right into Q&A. But Tony, thank you very much for being here.

Brian, you're welcome. Glad to be here, as always. You and Mario put on a great show. I think this has got to be, what, 20 years or so is 20 years or so.

This is my 18th and 49th total.

Do you want to take 1 minute just talk about the business or just give a better overview than I did.

You did a great job. But I mean, I will quickly talk about our business. So retail automotive, we have 356 franchises, predominantly premium luxury. We're based in the U.S., U.K., Germany, Italy, Japan, selling -- and now Australia is selling automobiles. We just expanded into Australia with 3 Porsche dealerships. We sell about 20,000 commercial trucks every year through 45 different dealerships that we have. It's all -- unlike Rusty, who just got these various brands we're specifically Freightliner. We're 100% Freightliner dedicated, looking to grow in that. We're both in Canada and in the United States based out of Dallas. And then we have a 28.9% ownership interest in Penske Transportation Solutions. There's 3 partners to that business. Us, Mitsui, who owns 30%; and our parent, Penske Corporation, who owns [indiscernible] that business is the 50% dividend policy that they have. So they pay us 50% dividend every year. And then they generate tax partnership that generates tax losses. Those tax losses passed to us via the partnership and we get to pay less federal income tax because of that. And then we hang it up on the balance sheet as a deferred tax liability. So it's a brilliant play with respect to doing that. And then with the one Big Beautiful Bill, as you guys were just talking about with Rusty, I think Mario's question was talking about the accelerated depreciation of things. We estimate conservatively that the one Big Beautiful Bill will give us an extra $120 million to $150 million a year in cash flow from the deductions that TTL will get in terms of expensing the trucks at 100% for all their purchases on an annual basis. That's based off of roughly $300 million of purchases -- or I'm sorry, $3 billion of truck purchases that they will do every year. So I left off a couple of zeros, I apologize. And then -- and it's amazing when you think about the cash that, that will throw out. We made our first investment, believe it or not, on July 1, 2008, what happened in September? Everything went to hell, right? But we bought 9% of the business, and then we bought 2 more tranches to get up to 28.9% in 2016 and 2017. And in total, we have $956 million in cash invested in that business. We've taken out $2 billion in cash. $2 billion in cash. Why do you think our debt is where it is, right? I mean it's -- we're in a great position with that business. Now there's some trials and tribulations going on with there right now. But Penske Truck Leasing this year has been relatively flat in terms of performance. We've taken out people. We've cut the vehicle fleet by 40,000, gone from 445,000 to 405,000 and what you see in terms of the pressures in our rental business, our commercial rental and consumer rental. And once the economy turns around or the capacity, as Rusty was talking about, comes out of the marketplace, you're going to see a company like Penske Truck Leasing become a first mover because people aren't going to be able to order and get trucks and haven't built on time, they're going to come to us, have us rent them the trucks. So we're going to be moving along pretty quickly right away. So -- and then on top of that, I didn't talk about the small business that we have in Australia. What's really interesting about that business is not only are we both providing on-highway trucks, we're doing an off-highway business, and I'm really, really interested in our Energy Solutions business today because we're providing the power plant that's going in and building data centers in Australia that's part of the AI revolution. So we've got AUD 1 billion under contract by 2030 to be able to supply these power systems into these big data centers. And it's -- honestly, it's less about that $1 billion. It's more about the service contracts that we get from those engines that are in service. And once they start hitting their useful life and they need to start having their service intervals, it's like printing money.

Yes. And just as a rule of thumb, you mentioned the $125 million or so a year in free cash flow. About $100 million by about $400,000, $500,000 -- $400 million to $500 million of revenue in a...

Yes, depending on what -- it could be a little less than that if it's super luxury or Porsche stores, BMW and Mercedes, those types of stores will cost a little bit more. Toyotas and Hondas will cost a little less. And honestly, if it's a truck dealership, costs even less.

Yes. I guess the broader point I'm trying to make is that just a growth engine for you to be able to increase your own profitability.

Right. And we just announced on our call last week that we have approximately $1.5 billion in the hopper to close before the end of the year.

Yes. And you just opened the -- or you just bought the Ferrari Modena.

We did. We bought Ferrari Modena, yes. May be the smallest acquisition but the biggest inflow simply in the overall company.

Let's take a step back and just talk about your core retail automotive business in the U.S., it's predominantly luxury. We've heard a couple of comments about there being some excess inventory with some of the luxury OEMs. Maybe just talk about what you're seeing in the higher-end business.

First of all, let's back up. Let's look at the industry in total. And I don't know if this has been talked about today or not, but the industry has got about 2.6 million units of inventory right now. That $2.6 million compares to $3.6 million, $3.7 million, $4 million prior to the pandemic. So the inventory is still down about 35% from where it was. Now you bifurcate that and you look at what we have. We have 50 -- 49 days supply in the U.S., 51 day supply in the U.K. So I think our inventory is in good shape. We have 20 days of Toyota, 18 days of Lexus, 70, 80, 90 days of Audi, okay? So Audi is a brand that doesn't have a lot of cache right now, it is very tough to manage because they don't have a lot of new product, okay. BMW, while their inventory at a little bit longer, I think, in the month of October, what we're comparing it against is a year ago where they were recovering from a stop sale that took place over 12 months ago. So the numbers in October last year were pretty darn high. So yes, we're down on a year-over-year basis in October for BMW. Nothing to get worried about yet. I mean I do think that we have to watch the inventory closely and see what it does, but I'm not overly concerned because the compare is really tough.

Broadly speaking, we just went over $50,000 in average transaction price. Your average ticket is obviously higher given your mix.

Yes, we are $60,000.00.

When you are examining strength of your customer base, whether it's FICO score, whether it's anything that within your F&I business, you can get some color on. What's your sense of the tranches of strength with the consumer?

So our subprime business is only about 6% to 7%. So we really don't even qualify to talk about that part of the business. I think every customer out there is a little squeamish with respect to affordability. I mean our average used vehicle transaction price is $40,000, new $60,000. That's up from $42,000 prior to the pandemic. So you take a look at that, higher interest rates even though they started to come back a little bit, you return to a dealership to lease a new car or purchase a new car and you get sticker shock. You really do. And what -- I'm not going to say it's a symptom of a customer or a problem with customers. What my symptom is or that I look at -- and the only thing that bothers me is that customers are now financing cars beyond 6 years, 7 years and 8 years, that's the part that bothers me. That's the part that we're watching very, very carefully and trying to dissuade people and ultimately, right, I want to sell a car. If a customer wants to finance a car at 8 years, even though I don't want them to because I want that customer back, I don't want to create a negative equity situation for that customer. That's really what concerns me more. They're pushing out that financing term more and more. Now how can we combat that lower interest rates. We've got 50 basis points of rate decline so far in the last few months, and that's going to help. We do 32% leasing. That's down from 40%, right? Leasing can be more affordable because you don't have to pay for the whole car, right? So we think that leasing will increase. And then the other thing that we see is that it's right around 26% of our customers right now are paying cash for their car. So they're trying to not finance it at the higher rate and pay for that car. So I still don't see a huge distress in customers of 26% can still pay cash for the car.

And where is that relative to where it's been in the past?

It's much higher. It's down from its peak. We were 32%, 33%, 35%, 36%.

When you're talking about an average sales price that is now $60,000 versus $40,000. I mean, it's basically your new car -- or your used car now is the price of what a new car was before COVID within a couple of thousand dollars.

And it's not -- I mean we're making bigger grosses off of those, obviously, because the selling price is higher. But this is -- we have to think about the strength of the OEMs. And if you look at all the OEMs that you follow, right, the OEMs have a better product lineup. They're not selling as many of the loss leaders that they had before. And we've got a mix shift to 84% SUV and truck that's driving the business as well.

Yes, Mario?

Yes. I've got a 4-year old BMW. I'm trading it in. I'm getting a higher price. So is it my net cost unchanged. Yes, no, maybe?

Well, it depends on what you have.

Yes, I agree with that.

And the miles. You're not driving very much, right?

I only do 15,000 miles a year.

That's still a lot. Okay. So it's -- that's not the issue.

I made that up, by the way. It's probably more than that.

It's definitely more than that.

My concern is the customer that buys a Toyota Camry or Honda Accord, right?

Yes. I got it. Yes. The second question for me is I got interest expense that everybody focused on. But that insurance company, all of a sudden is hitting me hard too.

Yes, they are.

How much -- what?

Yes, they are.

Do you have a number like what it would be today versus 2 or 3 years ago?

I don't.

It's okay.

Yes, I don't. I can look at my personal insurance, right, and it's probably up $1,000.

I don't blame them.

Yes, for me, for sure. exactly. You see how I drive.

Before you talked about enormous cash flow from the various rules that have changed. But that doesn't impact PAG's book tax. It helps your cash flow, but your book tax is like...

It doesn't help my tax rate. My tax rate stays the same.

And it helps your cash flow enormously.

Correct. And then I end up putting the deferred tax liability on the balance sheet.

Absolutely, yes. But I just want to make sure we understand the difference between the book tax, effective cash and the cash flow that shows up on the balance sheet, not through your P&L.

That's right.

Talk about the U.S. market. Franchise model is a lot different than maybe that which the Cavanas and CarMax's face. But what are you seeing as far as availability on the used side, quality, your ability to secure off-lease, which has to be down the basis?

Yes, it's a really good question, Brian. I think that's probably the toughest part of the business today is trying to acquire the right used car to sell in our dealerships, whether it's a standalone used business or in the franchise dealerships. We have very low lease returns. As a matter of fact, I think they bottomed out. I think from here, they're probably going to start getting a little bit better over the next few years. And it's not going to be like a huge jump. But it will be better. Right? It will be better than what it is today. We source 84% of the vehicles that we sell self-sourced. Those come from various different sources, the highest percentage is trade-in, which is about 55%. Our challenge is that we like the 0- to 4-year-old marketplace. We are not going after the 5, 6, 7, 8, 9, 10-year-old cars. So the 0- to 4-year-old marketplace is particularly difficult because everybody is looking for those and the prices tend to be elevated there. So the question then becomes, well, Tony, why aren't you expanding your view in going after older cars? And number 1 is I don't think we're good at it. Number 2 is those are the cars that end up causing high warranty rates, failure rates, costing more to get them ready for sale. And our customers -- premium luxury customers just don't want that.

Yes. [indiscernible] You mentioned it effectively, the 0- to 4-year-old car population is smaller and in terms of lower sales in 2020.

Right. So one of the things you look at, if you take and you go to our service business, right, that's growing very nicely, and we target mid-single digits in terms of overall revenue growth there. And quite frankly, we're growing our gross profit at a higher rate. So our margin is increasing. Our challenge on the service side is to get that Tier 2 group of vehicles and to bring them back in. These are the cars that would be 5, 6, 7 years old and might be beyond their second ownership cycle where you sort of lose track of that customer. So that's our focus on the used side and on the service side is to try to get more of those Tier 2 customers and Tier 2 vehicles.

Lesser talked about is the U.K. And just maybe a couple of minutes on just the market there and how that market's evolved.

So we do about $9 billion in revenue in the U.K. It's about 35% of our business. Great business from -- for the past 20 years that we've been over there. Right now, it's a bit challenged, I think, because of government policy. And Mario, I know that probably doesn't surprise you at all, but the government policy is making it very difficult on consumers over there. Whether or not it's an EV policy that's increasing every year and saying, look, if you don't get to a certain percentage of sales, you were going to have to pay a fine for not hitting a BEV target and that fine can be excessive, up to what is I think it's GBP 15,000 a car, right? GBP 15,000 of car for not hitting some arbitrary target. So the target right now went from 22% last year to 28%. Next year, it goes to 32%, the year after it goes to 38%. And then they're getting rid of the -- they're going to ban the sale of ICE cars by 2035 and ban the sale of hybrids by 2030. They don't want hybrids because, guess what, they found out the customers were buying the hybrid car to get the tax credit but never plugging it in. And then on top of it, you've got higher taxes. We've got higher taxes for social programs. Our SG&A was a little bit higher this last quarter until we can start to anniversary and take some more cost out because they've added health care taxes, minimum wage taxes that cost us probably $3 million each quarter right now. And then the consumer, whether -- I'm not sure if you guys know this or not, but mortgages in the U.K. are much different than they are in the U.S. In the U.K., the mortgages, I think they reprice every 5-ish years or so. So everybody has had their mortgage repriced at much higher rates, where over here, we can finance it at 15 or 30 years and not have to worry about it. So that energy prices and that have caused some challenge with the U.K. consumer. The market is still not bad. But there's some challenging factors behind it. We just got to continue to work through. Service and parts is really good over there. F&I is really good. And we've restructured how we do our used business over there and how we do aging of used cars, and we closed our car shop locations because they weren't making any money. We had too much overhead. We went to this -- you've heard us talk about this thing called Select. The Select is a used only business that ties into the dealership itself. So long story short with that is we've been able to increase our used vehicle grosses per car by several hundred dollars by just changing what we sell over there.

Yes. Tony, do you have any updated thoughts on the competitive threat of direct sales to the dealerships?

So we are working through agency for two brands in the U.K. right now. We are 100% agency with Mercedes. Mercedes is somewhat struggling with that. Mini went direct on March 1. And we're waiting to hear what BMW will do. Jag and Land Rover came back and said they're not going direct, but they don't like it. In the U.S., no direct sales whatsoever. The franchise laws are still in place. Do I think the manufacturers want to do it, some probably do. Others don't. Others like the dealership mix that they have and the fact that we can handle the customers themselves directly. So it's a mixed bag out there. I would say that Mercedes struggled a lot with it. Hundreds and hundreds of additional changes that they didn't anticipate that we had to help them out with. One of the big voids was lack of used cars in the marketplace and we still struggle with that today. The other part, believe it or not, is they came to us. And for those of you that don't know, when the manufacturer decides to go sell agency and go direct to the consumer in the U.K., they're controlling the selling price. They go from a negotiated transaction to here, so it's a 1 price model. Bottom line, everybody pays the same. So -- and I can talk more and more about that. But basically, that gives us an advantage if we're in population centers because the consumer that no longer goes out and negotiates. The problem with it is when they go direct, the manufacturer who said, we will take over and pay the marketing expenses, you don't need to pay any of those traditional expenses that you've had to pay. You don't have to pay floor plan, blah, blah, blah, stuff like that. Well, when sales weren't materializing, they came back to us and said, "Well, we need your help to sell more cars. We need you to go to the market, discount some cars. And we kind of went, "Sorry, this is what you wanted. You guys got to figure this out. We'll help you, but you got to figure this out. We're not -- you cut our margin." What we're doing, what I can tell you is that we're making more per car on a net basis under agency for Mercedes than we were when we were selling the car ourselves.

Brian, do you have a question? Can we get the microphone over here?

Tony, so I just want to go back to one of the questions, Brian asked, on the luxury demand. So if I heard you correctly, it sounds like there's some -- it is sporadic moves between the brands and with Audi, BMW, as I expect. But are you seeing -- if you step back, are you seeing a weaker demand -- weaker consumer demand for luxury lately?

Look, if we look at the last several months, I would say that it's probably a little weaker than it was in the first part of the third quarter. I would say, as it went through the quarter, September was probably a little weaker than July or August were. Now I'm not sure that if that's because people were out buying BEVs or if it was something more symptomatic than that. The other thing is we look at the month of October, we sold 130 BEVs, 130 in the U.S. Again, I'll say that again, 130. In the third quarter, in the U.S., we sold 4,200 BEVs. So the demand dried up. Over 50% of the BEVs that we sold were BMW. So -- and then on top of it, with that recall that BMW had the year before, I think it's too early to make a decision exactly what's going to happen there. Now if it's Audi, again, I'll say this again, Audi is a brand that is very, very, very challenging right now. I'd be surprised if anybody told you anything differently. It's just they've got to get their act together. Porsche solid, Jag, Land Rover is solid.

Over here. Go ahead, George.

Tony, I was just wondering if you could comment a little bit about on the addition of the Chinese dealerships in U.K. I know that you said the CapEx will be pretty limited because of the storage we've taken over. But you could you just talk a little bit about the strategy you have in adding those.

So for those of you that don't know, we announced last week that we have -- we're adding 8 Chinese brands into our dealerships in the U.K. We're putting in 3 Chery locations and 5 Geely stores. It is nothing more than trying something different, right? Trying something in the marketplace. They are clearly gaining share in the U.K. market. If you go back to the third quarter, and you look at the market itself, I believe that if you pulled out the Chinese brands, the market would have been down, but because the Chinese brands were there, I think the market was flat. So we think that there's some type of potential growth perspective that's there. So we're putting them into these Sytner Select dealerships. These are used only dealerships or what we've been treating them as used only dealerships. We're literally slapping a Chery or Geely sign on the front of the building. We're dedicating a little bit of the service area for Geely, doing a little bit of spit shining based on their corporate identity image and trying to sell cars. It's 40 cars a month.

What's the average transaction price delta between what they're selling and what the average alternative is?

So it's probably what we're selling there is probably GBP 30,000, so a lot cheaper, a lot cheaper. It's nothing more than just trying to get our hands around and see what's going to happen. We're going to put in two additional stores, one with BYD, one with MG in Germany to see if any of this makes sense. And if it does, if it makes sense, then we can grow great. If it doesn't, we don't have much invested in it, we pull back from there. So I tend to think that they're going to do okay though.

Thinking about your parts and service business, obviously, a major profit driver you've grown it really nicely despite the fact that 0- to 4-year old car population is smaller than you're addressing. As that population rises again, isn't that kind of a double boost for you or...?

I think so. Yes, I think so. We had record levels. I think the entire peer group has. Our parts and service revenue, if you look at Q3, what we just finished and you compare that back to where we were in 2019, it's up 35%. All-time record parts and service revenue growth. Our margin is high, I think as it's ever been. So it's driven by warranty and customer pay right now. Warranty is probably a little bit higher than customer pay, and it just keeps getting bigger and bigger. I don't know if you guys saw on Friday, Toyota and Lexus, we recalled the 1 million cars, 1 million. right? 1 million cars. So we're going to have to service those.

Warranty has obviously been a major growth driver for 5 or 6 years now. and I'll wrap up soon, but how much brand damage are these warranty issues doing relative to maybe what you would have thought they would have done? It doesn't seem like there's massive brand dilution from them over time.

It's not. And it depends on what the recall is, I think, too, right? This is the Toyota and the Lexus thing is a rearview camera issue. It's not like there's a catastrophic failure of the entire car. And look, if exploding airbags didn't cause your market share to go down and cause a big issue for you, I don't think anything well. I mean it's always something to be cognizant of. The biggest issue we have with Recall is the government process behind it. When a recall is announced and notifications to consumers take place, they want the damn car fixed. We don't even know what the fix is by the time when it's announced. Or when parts will become available.

We've always -- we've been part of that. Next year, you're getting 45 minutes.

I can keep going.

That's -- I know, but we out of respect for Harold. We're going to shut it down. I appreciate you coming over here, Tony.

No, you're welcome. I'm glad to be here. Remember, Rusty said something. The truck business is a little tough right now. But there's -- everything in this country moves on a truck. And once we get the capacity taken out of the marketplace, whether it's everything he was talking about and I didn't hear him mention the legals and the CDLs that are being granted and shouldn't be there. When that all gets aligned and gets better, that's going to take a lot of capacity out and look, these businesses are all going to shine. So thank you very much for your time. I appreciate it.

Thank you. Thank you very much.