Sonic Automotive, Inc. (SAH) Earnings Call Transcript & Summary

Welcome back, everybody. Sorry, we had a little bit of a technical difficulty on our end, so I apologize for the delay. Next up, we're very happy to have Sonic Automotive, one of the largest vehicle retailers in the United States. Management made a commitment to streamlining ops digitally in dealerships as well as establishing EchoPark, a stand-alone used vehicle business long before it was in vogue as it is now. It has taken some time to get these efforts off the ground, but they are really starting to roll and lift, especially at EchoPark. And Sonic has been outperforming on a traditional basis as the industry has gone through a constrained supply environment that's actually led to favorable macro dynamics, but has also executed incredibly well to take advantage of that environment. Today, we are very happy to have Jeff Dyke, President; and Danny Wieland, Vice President of Investor Relations and Financial Reporting. I really appreciate you guys joining us today, and thank you so much for the time.

Maybe to kick off first here, there's a lot to talk about, particularly around strategy, Jeff. It seems like, first, that COVID has been a shock to the system for a lot of dealers, including Sonic. It really has driven sort of an acceleration in strategy. In some cases, some small shifts in strategy. So just curious, as you go through this, you've evolved up through this crisis and you've gone through what's been a significant recovery and great performance from Sonic. What has been sort of the change in the mindset or the shift in strategy that's come out of this? And what opportunities may be greater or not as great as you thought before?

John, thanks, and thanks for having us today. Look, I mean, the beginning here of COVID at this time last year, the expense structure move that we made and the efficiencies in our whole entire operation have certainly played a big role, $70 million to $80 million in savings on an annualized basis. And those are savings that are permanently taken out of the business. We're much more efficient from a salesperson productivity level. And we moved from 10, 11 cars per salesperson per month on the franchise side to 17, 18. EchoPark has always been in the 25%, 26%, 27% range. But certainly, a lot of efficiencies that come out of, and it's sort of the silver lining of the pandemic. We've always been real strong at inventory management, both on the new car side and the pre-owned side and the EchoPark side. So that played a positive role for us, I think, throughout the time. We can talk a little bit about what happened in the summer with EchoPark, if you guys would like. But that, I think, also played a big role for us and our success. And then we've really enjoyed the tight new car day supply that certainly has come out of the pandemic, both from a manufacturer's perspective, because they're managing their inventory a lot better. So instead of having 60, 70, 80 days worth of inventory on the ground, now, we're in the 45 -- 40- to 45-day range. Still, with a 13.5 million retail SAAR, but now much, much better front-end margins. And I think as we look forward, we look to the chip issue and all that, which I don't think has really quite hit us. The margins that we're enjoying today are from just a much better managed inventory, both from a retail perspective and from a manufacturer perspective. So the last thing I would say is the EchoPark shift. We really learned a lot, as you said, in our first few years of operation. And we slowed down in order to speed up. We made great money and had great growth in '19. Unfortunately, the pandemic hit, but now, we're able to press on the gas pedal again. And we'll go from a base of 16 stores, our current count of 21, to over 40 locations this year. Should do right around $2.9 billion in revenue as EchoPark really starts expanding its footprint with our hubs and our delivery center model across the country. So it's a very exciting time for us the next few years. We've put some projections out there for EchoPark by '25, 575,000 cars sold, a little over $14 billion in revenue, and we're really getting that kicked -- our first year kicked off well. So a very exciting time for us here at Sonic and EchoPark.

That's incredibly helpful. I mean I guess EchoPark -- if you think about EchoPark and what you guys are going after, I mean, that's really the -- it seems like it's avenue and target for growth for you. And I think you had mentioned a target of [ 575 ], I think it's [indiscernible] between here [indiscernible] But it seems like you're taking a slightly more hybrid approach with the physical locations and online sales versus some new entrants that are almost purely online. I'm just curious why you think that hybrid approach makes the most sense? And really, what you're going to do. I mean, that kind of growth between the next basically, essentially, 4 to 5 years is really massive. I mean what are the key challenges to execute on that and actually get it done?

Yes. So one, we've got to get our footprint out. And that's going to require the 25 stores a year of growth. We'll hit that this year. We opened 5 stores already in the first quarter. A little back-weighted this year. We opened 4 in the fourth quarter, so 9 stores here recently. And so we've got to get that going. And we'll achieve that this year and next year as we move forward. And then the hybrid approach that you're talking about from an e-commerce perspective, we did a Harris poll. And we've done a lot of studies on just what does our customer want. And right now, under 9 -- under 10% of our customer base wants to complete an entire transaction online. So we're very focused from an e-commerce perspective on building a tool, and we've got sort of 2 swim lanes we're in right now. One is band-aid and make what we have today, which is competitive in the marketplace for the most part, work for the next few months. And then as we move into the fourth quarter, launch our new platform, which we're building right now. We've gone outside of our organization. We brought in a lot of e-commerce experience. And we've got a big, big focus on building, our website building, our digital retail tool, and building a platform that allows the consumer to make their own decision. If they want to do 10%, 15%, 20% of the transaction online, so be it, and then come in. If they want to do 100%, they're going to be able to do that as well. What we find and what we found through the Harris poll is about 80% of the customers -- 85% of the customers, they want to come online. They want to search and find their vehicle. They want to get financing options. They want to get a trade appraisal and get as much of the transaction complete as possible. But then they want to come to the store and actually drive the car. And very few want to complete the transaction overall. So we felt like creating the hybrid approach in this model that we've been working on, as you know, will best suit our customers and will allow our culture to not only be in-store that we have, but also be in our online solution that we launched in the fourth quarter.

Jeff, I mean, that growth is breakneck pace. I mean, as far as getting the physical location set, is that harder than getting the human capital and getting the stores set with a good GM and sales staff? I mean, how do you think about sort of the actual physical capital and then the human capital hurdles, both of which are pretty high to open 25 stores a year.

Yes. So we'll grow from 57,000 cars last year to 100,000, 105,000 cars this year. And part of the reason for slowing down was to put ourselves in a position to be able to do that. And we've done that. We've put the leadership team together, the training team together, the technology together and the organization together that will allow us to grow, both from a real estate perspective and going out and buying facilities. I've got a list of facilities sitting next to me that we'll execute this year. And then from a human capital perspective. These are sort of capital-light when it comes to the dollar. So it's not a huge expense. We open up a delivery center. It's a couple of million dollars to get that done. And so it's not huge capital expense, but it is human capital-intrusive. And so we've worked very hard. We're hiring general managers a year in advance now. That's part of the $12 million to $14 million drag that we put out there for this year that we'll have with EchoPark. Although EchoPark will be accretive to the organization this year. Next year is when you're really going to see, we'll have a big enough footprint to eat up some of the drag of the 25 stores that we open up next year. So we slowed down to speed up. We're prepared -- very prepared for the rollout. And then, of course, this year, we added a little twist. We went out and we bought the Used Car King group and Carbiz -- Used Car in Syracuse, New York and Carbiz in Maryland, Baltimore, Maryland. And those deals were perfect fits for us. Actually, the principals of those stores had tried to open up an EchoPark-like facility. They actually came to our stores, studied our model, failed at the model, but got a lot of it right. They just couldn't get the buying, the inventory, transportation, the pricing, the reconditioning, the merchandising right, and in the day supply piece, correct. So we've gone in. We've [ tapped ] in that. And what's great is, is our Used Car King who we closed on, now, we're in our third, fourth month. They'll already be profitable this month. So huge impact there. And they've got great capacity. So one of the big selling points to us was I can get about 2,000 cars a month out of the Used Car King platform, another 1,700 cars a month out of the Carbiz platform, which allows us to open up delivery centers off of those platforms and really take over those parts of the country with the EchoPark brand and our pricing model. So we're very, very prepared for this. We did slow down in order to make sure that we had that right, that the model is working. And now, we see it working in our delivery centers, our medium-sized hubs, our big hub stores, and now, with these latest 2 acquisitions. So it's all really come together for us.

And can you remind us how the delivery sectors work versus the main stores or the hubs? And how many of those might be supported off of a hub store if you will?

Yes. So our first delivery, for example, was in Greenville, South Carolina there. And really, we're using an old mini store. An office in an old mini store. We did, I think mid 100s, 166 cars coming out of December. And -- it might have been January. Either way. Our Charlotte store, our Nashville store and our Tampa store actually feed inventory into that market. So really, there's no inventory on the ground in the marketplace. We're delivering the car to the marketplace for the customer, but we're not delivering that last mile which is incredibly expensive and complicated. And so the customer's coming to us. They're driving a couple of miles to get to us. And we're bringing the car into the marketplace. Our CSI scores have been fantastic. And so now, what we're doing is opening up those delivery centers. We've got Knoxville, which is now ahead of pace from where we had Greenville. Our F&I numbers are very good coming out of that, coming out of the delivery centers, which that's all done online. And now, Knoxville is in the same relative F&I range as the rest of our hub locations. So the hub, it's like a hub and spoke. The hubs are actually feeding the delivery centers across the country. And that's -- they're not big facilities. The rent factors are low. Typically, we're leasing them. They're $10,000 to $15,000 a month. A little bit of CapEx, all about $2 million and under. We can open these, and then we just have an immediate route in a radius around our hubs, call it, 300 to 350 miles.

It's not about the -- this is Dan. John, I would add to your point about what is the support and the capacity for a retail hub. You're going to see 3 to 4 delivery centers on the retail hub, particularly a larger size hub, as we evolve. And we will put all those in their lots, we'll open them in sequence to allow that retail hub to build up to the reconditioning capacity that'll serve it. And really, that's where that physical plant comes in, so that hybrid model is that in order to enable the logistics require of an e-commerce online model, you've got to have the reconditioning, the procurement, the inventory storage capacity. And we feel that the hybrid of using that as our reconditioning for the e-commerce model as well as retailing vehicles at that site, so it's 90% of customers today are still buying online or coming into the dealership on site, it gives us the best of both worlds for today's buying environment.

Yes. No, I agree with you. It's a large physical good that needs to be processed. You can't zap us over an e-mail or a text or something like that, or Amazon it. It's a very different kind of product, so those physical locations really do matter. When you look at the capital markets right now, there's a lot of support for businesses that are perceived or actually are real growth businesses. I mean, you have a competitor out there on the used car side called Carvana, which I'm sure you're more than well aware of, that has access to fairly low capital. Has it ever crossed your mind, and I'm sure it has, that you might consider raising capital off the back of what appears to be a really great growth part of the business that may help accelerate the business? It's not just to take capital in that's low-cost, it's actually then to redeploy and really accelerate the growth opportunity that you're going after. Or do you believe that you have enough internal capital that really capital constraints wouldn't really allow you to go that much faster? And they're going pretty fast, right? So I'm not knocking it all.

Yes. So I'll take a shot. That's the -- it's not the capital constraints. We have the capital to -- because we're really a capital-light model. It's the human capital. These 25 stores that we're opening a year, I feel, is right in our sweet spot. We practiced for that, we've modeled it, and that's our sweet spot. I think you start getting into 30, 40 stores and more delivery centers, it really starts stretching our team a little too far. We are going to add a kind of a hit squad that we'll use because I do think there's going to be some more opportunities to acquire more dealers that were like Used Car King and Carbiz, but that's an opportunistic situation only. It doesn't take us away from our main course here in getting our 25 stores a year open here for the next 5 years. But there are going to be some opportunistic opportunities, I think, to buy some stores that really fit the model, have capacity, are one price, understand the culture or an easy conversion, and we don't have to go out and hire all the human capital to get the store up and running, and perhaps already doing a couple of hundred cars a month so we can leapfrog from there. And so there will be a little bit of that kind of activity going on. And so we would add some headcount for that, but we don't need any resources to do that from a capital perspective.

But Jeff, those acquisitions would be surely incremental to what you've outlined by 2025 of 140 points and 575,000 cars sold. Would that -- is that correct? Or are they embedded in that -- in those targets?

They're embedded in those targets. It's a way for us to evolve and to reassure that we'll reach to those targets. And as you said earlier, they're lofty goals. Syracuse, New York may not have been a market that we would have attacked because of its size, but given the opportunity there and given this -- the facility that was there, a brand-new facility that looked just like EchoPark, all we had to do is change the sign, and then we're off to the races there already. That begs the question, gosh, there could be a few more of these down the road. I need a team to work on that, so we'll be implementing that here over the next couple of months as we look. We've already looked at a bunch of deals that are not a fit, that we would never do. We certainly don't want to disrupt what we're doing. But if there's a fit like Used Car King or Carbiz that could help reinforce hitting our target, then we'll take a look at those.

And I think the important point to that is that these are comparable initial capital outlay as if we were building a greenfield and starting from scratch. Both of the acquisitions, they fit from a similar ROI profile as a medium hub location. And so as we evaluate the fit of these existing potential targets or the way they currently operate the business, the culture, the human capital, it still comes back to, what is the return on that investment? And so that's the key criteria where we have to adapt and evaluate whether to do an acquisition to grow [ like our VaR ] or to do a great deal in a certain market?

The difference with the acquisitions is the business is up and running, and there's not a maturity curve, so the ROI is achieved in a bit faster fashion than it would if a greenfield. Is that a fair statement?

Exactly.

It's happened in the first one. And so without question -- I don't have enough time under my belt on the second one, but that's the logic, and that's the thought behind the idea.

Got you. And then, Jeff, you alluded to the omnichannel efforts progressing. I'm just curious, as you think about layering on sort of the digital overlay, if you will, to both your core business on Sonic and EchoPark, is there an opportunity to wrap these 2 businesses together and get them presented to the consumer in one place online or via apps that really accelerates the entire business on the new, the used, the parts and service side? Or is that a modeling story and you would never want these businesses somewhat co-mingled in a representation of the consumer?

Yes. John, in another life. I spent a lot of time at AutoNation, as you know. And we modeled those businesses together, the mega stores and the new car business. And it really didn't work out. I learned a big learning lesson doing that. And so I don't think that, that's an alley that we would go down. EchoPark, we built to stand alone on its own 2 feet. And we've got a really good success story, a really good growth story, a great couple of years in front of us. And I don't think it needs it. I think it's very healthy. The franchise business is extremely healthy, as you know, as well. In particular, with our cost cuts and the brand mix that we have. I just feel like these 2 businesses will need to be apart. And there's some synergies there. There's no question about that. In particular, the trades that we take at EchoPark, that are above the 1- to 4-year on the 50,000 model that we have at EchoPark, to send those into the franchise stores. And there's some synergies with personnel and corporate and all of that kind of stuff. But the businesses need to operate on their own 2 feet, and that's a big lesson from the past that I don't want to repeat again.

Good. And I mean that's all exciting. And so is your core business, right, on the new car dealership side. So maybe switching gears to some of the positives that have been going on there. I mean, you alluded to a shortage of supply, which has been very healthy and not constrained demand too much, but it's definitely driven very high grosses. So with all the supply chain disruption and what looks like to be an inventory levels that are going to remain relatively tight here in the near term, where did you see grosses -- maybe not too specifically because I don't want to pin you on trying to give any kind of guidance. But I mean, grosses on the new vehicle side, we all kind of thought we're going to normalize and ease through the first half of this year. And it certainly doesn't seem like inventory is ramping up. So do you think there's an opportunity that the industry maintains fairly high grosses through the course of this year? And then maybe even on the other side, that the automakers have finally been forced into this test that we've all been pushing them to do and say, hey, just hold off a little bit on this production. You might get a lot more money yourself and the whole value chain might be a lot more profitable, and it just happened. We saw it happen. It's kind of still happening here in the near term. Will that -- that pressure on supply just this year? And then do you think you're hearing or feeling that there's any kind of mindset change here because you saw a record profit to some of these automakers for the second half of last year, and they were making less vehicles. It just was great. I mean, it was just the way it kind of should work, maybe if you take a step back. So what are your thoughts maybe sort of near term, and then as we get through the supply chain pressure?

Look, I think the manufacturers have blasted on several dealer boards and obviously spent a lot of time dealing with the manufacturers. And I think the manufacturers learned the biggest lessons ever. They're treating the new car day supply like we treat used car day supply. They tightened the day supply up. We're still selling the same number of cars. We're selling cars. The retail SAAR is 13.5 million or so. And I think they're going to keep day supply tight. And I was talking to a manufacturer over the weekend. And he said, "Gosh, Jeff, at the end of every year, I have a $100 million problem. I've got to give incentives and do all kinds of stuff to get the previous model year out." This year, I had $100 million surplus, and we don't want to screw that up. We want that to keep going. You need to continue to yell from the fences, because I've been yelling about this for years, as you know. We have got to have a control over our day supply on the new car side. And it does us no good at all for the highline deal or any of them for that manufacturer or any of them for that matter to have 60, 70, 80 day supplies. It's just a waste of money. So we could still sell the same number of cars, if not more, all make a lot more money, reinvest in our businesses, grow our businesses, buy other businesses. It just makes all the sense in the world. So I think you're seeing kind of 2 things happen here. One, I think right now, the margins are high all the way through March, not because of a chip shortage, but because the manufacturers are doing a stellar job managing their inventory. I think we're going to go through the next 3 or 4 months or so a little bit of a bumpy road because of the chip issue. But when we come out of that, I do not expect the manufacturers to bring inventory levels back to the days of 2019 and before. And because of that, margins are going to stay good. And I just don't see that changing. And I can tell you, from my position, and I know my counterparts are all bellowing the same exact sentiment to the manufacturers, it's just incredibly important that they learn the lesson from COVID and take that through over the next few years. Well, I'll make a hell of a lot more money, sell a lot more cars. And I'll be a heck of a lot better off and be able to help and support the economy. It's just there's no question, it's certainly a better position to be in.

And you're seeing a similar dynamic on the used side where there's a relative shortage of vehicles relative to demand, which is driving up used vehicle pricing. So just curious how long you think that persists, but also there's this structural shift that you are facilitating through EchoPark, where you have a greater professionalization of the used car market, which makes customers more comfortable, which will support used vehicle pricing. So I mean that seems like a dynamic that also beyond just this near-term supply-demand balance which is good for used vehicle pricing, might also help out. And then that just kind of reverberates up into the new business and helps up pricing there. So I mean, do you agree with that logic? And I mean, does -- is this going to stick around, this relative strength in used vehicle pricing? Or could we see a collapse?

No. I think for the near term, for sure, used vehicle pricing is going to be -- it's going to continue to stay strong, and the margins are going to continue to stay strong. We came out of last year that way, and I don't see that changing either. I mean, look, this is not the price increase that we saw in the middle of the summer last year that caused all kinds of problems when the wholesale index outpaced the retail index. Right now, you have a nice increase in the wholesale index and the retail index is keeping up with it, and it's driving great margin for all of us. It's driving good margin on both the EchoPark side, the franchise side, and I know my competitors. So this is a time that you really take advantage of that. There's a little more seasonality in the used car pricing, I think, than new. And maybe a little more volatility. But I do think for the remainder of this year on both the new car side and the pre-owned side, we're going to see nice margins and the higher prices.

Got it. And then one part of the business, which is not getting any airtime right now or much airtime as parts and service, which pre-COVID was the key, and it's still a key part of the business, right? I mean, it's making a lot of money here in parts and service, and nobody's talking about it. It's not snapping back as quickly. I mean, it seems like all these dynamics that we're talking about on the used and the new side, we'll get to Jeff and Dan in a minute, will stay pretty positive for a while. I mean, when do you think the parts and service business starts comping positive and recovering and -- it might take some time, but I mean, I got to imagine it turns positive soon. So I mean, what is your take on that? And what kind of opportunity is there still there?

Yes. So it's going to come back. I mean, we were really starting to take off in January and February. Our customer pay business was up 12% of '19 -- or excuse me, of '20, and then COVID hit. And so we've got it forecasted in our models to start coming back in the back half of this year, but it's going to come back. People -- once the vaccines get out and COVID is not the topic of every TV station on the planet, we're going to start having people travel again, maybe not fly as much but maybe drive more. And so our service lines are going to fill up. We're starting to see a little bit of that now. It's different. It's very regionalized, too. You get out into Northern California and Southern California, and it's still -- in particular, Northern California, big time lockdown. And so it's a lot harder to come back that way from a fixed perspective. But as you move towards the East Coast, you get to Texas, Florida, things are beginning to normalize. Business is returning. And the numbers look pretty good. So we could talk a lot more about that as we get to the first quarter call. But we're projecting the latter half of this year, things begin to turn to normal for parts and service. The collision repair business, we'll see. I think there's going to be a little longer lag there, but that's a real small percentage, 2%, 3% of our overall. So it's not a big piece to us.

Got it. On the SG&A side, just to touch on that again real quick. I mean if you can remind us what you've done there? What you think you can maintain? I mean, that's a real cost-cutting that went pretty quickly with COVID. But I mean, how much of that do you think you can maintain, if you can remind us. I mean, as the business recovers, do you think you can really hold on to these savings? Or is there going to be some cost-free or necessary return of cost as the business really bounces back this year?

We're going to keep the $70 million to $80 million out permanently. That's what we told the world we'd do. And the reason we're able to do that is we're more efficient. Our technology allows us to do it. I've been saying this for a while, we should have done it before COVID, but the competition out there wasn't just allowing it. So now that we've made the cuts that we've made, we've gone from selling 10, 11 cars on the franchise side -- if I said this earlier, sorry -- 10, 11 cars now to 17, 18 cars. And that's much better efficiencies. I think we can push that to 20. EchoPark sits at 25, 26 cars per sales associate. We have more throughput now due to technology, through our F&I associates. The same thing through our sales managers. So we're going to keep that out. We've cut $7 million a year out in travel expense. We're doing what we're doing here today. And these expenses are just expenses that are not going to return. We need to keep those dollars out. We want to redeploy those dollars in areas that are going to be a lot more effective like EchoPark and our growth there. So we'll keep those expenses out and continue to grow the business.

[indiscernible] it seems like it will remain a pretty decent positive on year-over-year basis [indiscernible] comes back and rates go up a little bit. But I mean, as you think about [indiscernible] and financing expense going forward with potential risk for rates rising?

Look, the best of both worlds right now. Shorter inventories and low interest expense is nirvana for us, right? So yes, the interest rates can take a little bit of a bump up. Even with that, with the lower inventory levels, it makes a big difference. So that's not something that in this year -- I mean, I think the rates are going to stay the same throughout the rest of the year. But I'm not too concerned about that. I'm really excited. I mean I'm excited for our industry. And apart for me to say, I'm very proud of our manufacturer partners for really catching on to the inventory management piece. And I think that -- I don't know that 100% of it because somebody is going to get a little squarely, but I think a good majority of it is here to stay, these best practices.

We're running short on time, so I'm going to ask one last question. I mean, if you look at [indiscernible] cash flow basis, what are the priorities for [ cash either ] to reinvest [ buybacks ]. What -- how do you think about [ capital ] --

John, I'm sorry, you're breaking up.

If I heard you, John, I think you were asking about our capital allocation priorities and strategy?

Correct. Yes. Sorry, Danny. Yes.

Go ahead, Danny.

I was going to say, of course, priority #1 is EchoPark expansion. We've modeled about $75 million of CapEx this year related to EchoPark, which is pretty low in terms of opening 25 locations. Very high ROI on that spend. We do have -- historically have had a share repurchase program to at least offsetting dilution. And then you'll see the excess cash flow that we've been generating, especially with the expense reductions on the franchise side, with seen significant improvement in our free cash flow above and beyond what's required for EchoPark expansion. So you'll see some strategic tactical M&A on the franchise side as well. Because, again, that is a big piece of our business. And while we have organic growth opportunity there, there's certainly some opportunity to get into the M&A market in that piece of the Sonic portfolio.

Got it. With that, we're running low on time. So I really appreciate you guys joining us, Jeff and Danny. Thank you so much for the time. We look forward to seeing you in person sometime soon. I hope we get to spend a little bit of money on business traveling, at least buy you guys a beer for doing it. So we appreciate it so much. Thank you so much for the time.

We look forward to that, John. Thank you so very much. Appreciate it.

Thank you very much.