Should You Be Worried About This Auto Heavyweight's Q3 Performance?

Sometimes they don't save the best for last. As the final auto dealer to release its third-quarter earnings, Penske Automotive Group (NYSE: PAG  ) was expected to knock it out of the park – and it didn't. Though the company reported good stuff, numerous record-breaking statistics from the other public dealers left Penske's decent results in a dimmer light. Here's what you need to know.

Snapshot take

  • Revenue and adjusted EPS results beat analyst estimates for the third consecutive quarter. 
  • All segments produced revenue and gross profit growth, with new vehicle revenue up 16% over Q3 2011.
  • Adjusted EPS growth was 20% versus the prior year quarter.
  • Margins were down across the board compared with Q3 2011.

Revenue
Like its compatriots, Penske reported revenue growth in all same-store retail segments, when compared with 2011:

Same-Store Revenue Category

% Change (2011-2012)

New Vehicle

16%

Used Vehicle

8%

F&I*

13%

Service and Parts

2%

Total Revenue

17% 

Source: Penske Q3 2012 earnings press release;
*F&I represents warranty and insurance packages that accompany vehicle sales.

But Penske's results don't stack up to its competitors'. For example, the other auto dealers reported record F&I revenue left and right in the third quarter of 2012, with an average growth of 20%-plus on a same-store basis, but Penske didn't.

Brand mix is at fault. Penske is largely focused on luxury brands, which regularly provide customers with complimentary maintenance and warranty packages. Since F&I sales are customer purchases of extended warranties, service contracts, and the like, it's difficult for luxury dealers to sell upgrades when complimentary options are comprehensive ... and free.

Margins
F&I income is pure profit; with those numbers down, Penske inevitably had to rely on vehicle margins to compensate for lost income. Unfortunately, manufacturers brought the hammer down on new vehicle margins during the third quarter, as they tussled over market share using competitive pricing.

Penske's gross margins weren't its only weak spot. The dealer's margins deteriorated across the board, suggesting that even if vehicle margins improved, any benefit would be lost as it flows toward the bottom line:

Income Type

Margin Decrease

Profit Increase

Gross

0.9%

10.9%

Operating

0.1%

11.4%

Adjusted Net*

0.6%  

19.1%

Source: Penske Q3 2012 earnings press release;
*Net margins are adjusted for one-time items (2012 -- debt redemption costs; 2011 -- net tax benefits) 

EPS
For the sixth consecutive quarter, Penske's EPS beat analyst estimates. Boosted by record adjusted income from continuing operations, EPS grew 20% from Q3 2011, ending at $0.60 per share. Penske's earnings are adjusted for $13 million in costs associated with a debt transaction.

Sources: PAG Q3 press release and Bloomberg Businessweek;  

Earnings growth is the one area in which Penske measured up to the rest of the auto dealers, boding well for the company's ability to keep up going forward.

Other notable results
Penske was hit hard by Hurricane Sandy at five of its locations along the East Coast. Sandy's impact may be deeply felt in Penske's fourth-quarter results, with up to four days of disrupted operations at dealership locales representing 17% of the company's retail unit sales and revenue.

The company reduced SG&A expenses as a percentage of gross profit to 80.1% -- a markedly inferior result to its competitors'. One explanation: Penske's penchant for leasing its dealerships -- a distinction from the other dealers, which  prefer to own their real estate. But taking a closer look at the composition of all the dealers' SG&A expenses makes clear that Penske's leasing approach isn't the only reason it's at the bottom of the pack.

Company

SG&A as % of Gross Profit

SG&A (Excluding Rent) as % of Gross Profit

Rent as % of SG&A

Penske

80.1%

71.4%

10.8%

Asbury Automotive (NYSE: ABG  )

72.3%

67.7%

6.4%

AutoNation (NYSE: AN  )

70%

69.9%

0.1%

Group 1 Automotive (NYSE: GPI  )

74.2%

65.8%

11.3%

Lithia Motors (NYSE: LAD  )

66.8%

64.1%

4%

Sonic Automotive (NYSE: SAH  )

77.6%

68.8%

11.3%

Sources: Company press releases and/or 10-Qs  

Sonic and Group 1 not only have a higher percentage of SG&A expenses dedicated to rent than Penske does, but they also have considerably lower SG&A expenses as a percentage of gross profit. Both companies enacted comprehensive cost-cutting initiatives during the auto industry's downturn; Penske hasn't detailed as great an initiative to do the same.

Penske fared rather well during the downturn because of its luxury vehicle sales, which were fairly consistent during the recession, so there may have been less pressure for the company to slash expenses. But as the industry rebounds, the companies that made concerted efforts to reduce costs are being rewarded with record-breaking earnings.

Investor sentiment
Penske has a three-star rating on Motley Fool CAPS, with a 118-19 rating of outperform by CAPS members. Based on All-Star CAPS members (the highest-rated CAPS participants), 38 of the 41 believe the stock will outperform.

Six of 13 analysts on Yahoo! Finance recommend Penske as a buy, with four listed as a "Strong Buy." The five analysts not recommending a buy say the stock is a hold.

Outlook
Historically, the fourth quarter is a boom-time for luxury-vehicle sales. With 68% of its brand mix in luxury/premium, Penske will capitalize on the holiday sales season, though margins may be under fire again from manufacturers' competitive pricing. Look for Penske's fourth-quarter results to dominate the auto-dealer segment.

Though its earnings may not signal a desperate need to reduce costs, Penske would benefit from a close inspection of its expenses. Any available cost-savings could turn the company's good operations into great ones during the industry rebound, allowing Penske to boast just as loud as its competitors about breaking records. It's not too late for the auto-dealer juggernaut to make adjustments necessary to blow other dealers away in 2013.

Penske's not the only auto stock that has shown some weakness lately, though it's still performing incredibly well. Ford has been a great performing company over the past few years -- it's making good vehicles, is consistently profitable, recently reinstated its dividend, and has done a remarkable job paying down its debt. But its stock seems stuck in neutral. Does this create an incredible buying opportunity, or are there hidden risks with the stock that investors need to know about? To answer that, one of our top equity analysts has compiled a premium research report with in-depth analysis on whether Ford is a buy right now, and why. Simply click here to get instant access to this premium report.


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 2101006, ~/Articles/ArticleHandler.aspx, 7/24/2014 4:22:56 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement