Penske Automotive Third Quarter Earnings: In the lead, but risks remain (NYSE:PAG)

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holding up well

Penske Automotive Group (NYSE: P) continues to lead its competitors and deliver a positive total return this year. Since my last review in July, the stock is down 10%, but recovered that drop after his 3Q Earnings Release.

Penske Stock vs. Competitors Chart

looking for alpha

Penske’s diversification with truck sales and leasing, international operations and growth plans for traditional dealers and used car superstores have earned it a higher P/E than its peers. PAG has gone from being the second cheapest of the bunch to the second highest value on a final P/E basis. CarMax (KMX) is not shown on this chart because its P/E is much higher than the others.

Penske P/E vs. Competitors

looking for alpha

Penske continues to surprise shareholders with its return on capital. In June, the company ended its long-standing dividend policy of increasing the payout by $0.01 per share each quarter and instead increased it by $0.03 each quarter. Instead of sticking with this policy for a while, Penske has already increased the dividend by another $0.04. A payment of $0.57 is now scheduled for 12/1/22. It is unclear if the company will continue to raise quarterly gains at this rate, but if it did, PAG would have a forward yield of 2.3%. Penske also continues to reduce the share count, which is now down 7.2% in the past year. The company bought back another 0.9 million shares in October (about 1.2% of outstanding shares). It also has another $268.2 million in repurchase authorization that would reduce the number of shares by another 3.3% when completed.

Penske has achieved these results despite continued declines in same-store sales volume and currency difficulties with 29% of its sales in the UK and 7% in countries other than the US. However, Penske continues to grow the overall auto business through acquisitions and new-build dealerships. Penske bought 19 dealerships and opened 2 new ones so far this year. The truck sales and service business, or PTG, and the truck leasing business (PTS) are holding up better than the car business. Penske is also growing the truck sales business through new deals, buying 4 Canadian dealers this year. The new acquisitions will add $550 million in sales this year and $1.3 billion annualized, or about 4.7% of Penske’s total sales.

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Penske is a well-managed company and has weathered unstable economic conditions well over the last 2-3 years. However, the entire industry could now see weakening demand due to an economic slowdown, even as some of the supply constraints are eased. This would be a double whammy for earnings, ending the rapid growth of 2020-21. Penske is in good shape to ride out a recession, but the stock is likely to take a hit along with the rest of its peers. PAG is a good long-term hold, but I still think general macro concerns could affect the industry over the next year, which would not make me a buyer here.

Lower volumes and F/X headwinds

Penske sold 114,400 cars at its auto dealerships in the third quarter of 2021. Since then, volumes have been significantly reduced at the same store as a result of supply issues. Cars sold at dealerships less than a year old stood at 6,000 cars in Q3 2922. This alone brings total sales to 110,000, which is still 4,800 less than a year ago and about 5,000 less sequentially. High demand and tight supply of new cars allowed the company to achieve an even higher gross margin per unit on new car sales, financing and insurance. Still, currency headwinds took about 6% off margin growth.

Penske Auto Sales Metrics

Penske Automotive Group

Used car gross margins continue to decline due to tight supply as fewer new car sales mean fewer used car trade-ins. Large used car stores CarShop, while still growing year-to-date, had lower sales volumes and revenue than a year ago.

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On the bright side, US overall industry monthly auto sales have risen since I wrote three months ago, but are still down from the strong monthly figure seen in 1Q. This could be due to gradually improving supply chain issues, but the risk of a recession bringing down these sales remains a possibility.

Total Vehicle Sales in the United States

Total Vehicle Sales in the United States (Commercial Economy)

Truck sales and leasing continue to do well

Penske’s commercial truck dealers still contribute only about 11% of Penske’s pre-tax earnings. Sales remain strong. PTG sold 25% more trucks at the same store in Q3, matching YTD volume growth. Gross margin per truck increased 14% from last year in both periods. The services and spare parts business, which concentrates most of the unit’s profitability, also shows strong growth.

The Truck Leasing Business (PTS) is another business unique to Penske, PAG owns 28.9% of PTS and accounts for its share of PTS revenues by the equity method. This revenue is up 15% from last year to a record $468 million in the quarter. PTS now represents an even larger share of PAG’s pre-tax earnings, at 31% in Q3.

Penske Transportation Solutions Performance

Penske Automotive Group

capital management

So far this year, Penske has generated $1.01 billion of free cash flow, a decrease of $1.17 billion in the first 9 months of 2021. The company increased its spending on acquisitions this year to $393 million. They also paid $114 million in dividends and bought back $585 million of shares, nearly triple the 2021 level. The company added a small amount of long-term debt this year, $186 million in a mortgage against a dealer. These data are visible in the statement of cash flows in Form 10-Q. Leverage remains low at 0.8 times net debt/EBITDA, an increase of just 0.1 from last quarter. (Net debt excludes short-term floor plan debt, which is used to finance vehicle inventory.) Vehicle inventories on sales day have not changed much from last quarter. Floor plan interest more than doubled compared to last year due to higher interest rates, but total debt including floor plan is still well covered by operating income at 11.4x.

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I still think Penske can maintain its best-in-class growing dividend, even with higher floor plan interest and eventual inventory buildup as supply chain pressures ease. With leverage currently above the lowest in its peer group, Penske has room to increase debt if needed without hurting its credit rating. In the worst case, the company has room to cut back on buybacks to keep increasing the dividend.

conclusion

Penske Automotive shares trade at a slight valuation premium compared to most peers, reflecting the company’s growth, diversification and balance sheet strength. PAG remains rare among its peers with a positive total return year to date. The valuation still looks cheap with a trailing P/E of 6, but this reflects concerns about peak sales and margins as a recession could be on the way.

The racetrack is still under a yellow flag with Penske in the lead. His strengths should allow him to maintain this leadership, but an economic downturn would affect the shares of all companies in the industry. Penske is a well-managed company, but the stock is still held. A recession would allow the entry of new buyers at better prices.

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