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Penske Automotive Group, inc (NYSE:PAG)
Q3 2021 Earnings Call
Oct 27, 2021, 2:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen, welcome to the Penske Automotive Group's Third Quarter 2021 Earnings Conference Call. Today's call is being recorded and will be available for replay approximately one hour after completion through November 3, 2021 on the company's website under the Investors tab at www.penskeautomotive.com.

I will now introduce Anthony Pordon, the Company's Executive Vice President of Investor Relations and Corporate Development. Sir, please go ahead.

Anthony Pordon -- Executive Vice President of Investor Relations and Corporate Development

Thank you. Jerome. Good afternoon, everyone and thank you for joining us again today. A press release detailing Penske Automotive Group's record third quarter 2021 financial results was issued this morning and is posted on our website along with the presentation designed to assist you in understanding the Company's results. As always, I'm available by email or phone for any follow-up questions you may have.

Joining me for today's call are Roger Penske, our Chairman and CEO; Shelley Hulgrave, our Chief Financial Officer; and Tony Facioni, our Vice President and Corporate Controller. Our discussion today may include forward-looking statements about our operations, earnings potential outlook, future events, growth plans, liquidity and assessment of business conditions. We may also discuss certain non-GAAP financial measures, such as earnings before interest, taxes, depreciation and amortization or EBITDA. We have prominently presented the comparable GAAP measures and have reconciled the non-GAAP measures in this morning's press release and investor presentation, which are available on our website for the most directly comparable GAAP measures. Our actual results may vary because of risks and uncertainties outlined in today's press release, which may cause the actual results to differ materially from expectations. I direct you to our SEC filings, including our Form 10-K for additional discussion and factors that could cause results to differ materially.

I will now turn the call over to Roger Penske.

Roger Penske -- Chairman and Chief Executive Officer

All right. Thank you Tony. Good afternoon, everyone and thank you for joining us today. I'm pleased to report all-time record third quarter results for PAG, in the best quarter in the history of the company. Our total revenue increased 9% to $6.5 billion and income from continuing operations before taxes increased 53% to $476 million and income from continuing operations increased 44%, the $355 million and related earnings per share increased 45% to $4.46. Although unit sales were impacted by supply shortages in both our retail automotive and commercial truck dealership operations, earnings growth was driven by a 39% increase in retail automotive, 135% increase in commercial trucks variable gross profit per unit retailed, also 4% increase in retail automotive service and parts gross profit and a 230 basis point reduction in SG&A to gross profit and $15 million in lower interest costs coupled with an increase in commercial truck dealership EBT of 106% and an 83% increase in earnings from Penske Transportation Solutions. This demonstrated the continued strength of our investment and the benefit provided by our diversified business model.

Looking at our retail automotive operations on a same store basis for Q3 '21 versus Q3 '20, units declined 8%. However, revenue increased 7%. Gross profit increased 18% including 180 basis point increase in our gross margin. Our variable gross profit increased 39%, to $5,769 per unit compared to $4,152 last year. Looking at CarShop, we now operate 22 locations and expect to open one additional location by the end of the year. We recently added locations in Leighton Buzzard and Wolverhampton in the UK and our Scottsdale location opened this week.

During the quarter, CarShop unit sales increased approximately 1% to 18,451 units, revenue improved 24% to $438 million and gross profit per unit increased 12% to $2,668. Our current annualized run rate is approximately 70,000 to 75,000 units representing revenue of $1.6 billion and an EBT between $45 million and $50 million.

Turning to the retail commercial truck dealership businesses, our Premier Truck Group represented 11% of our total revenue in the third quarter. Retail revenue increased approximately 26%, including a 6% on a same store basis. On a same store basis, retail gross profit increased 40%, including a 10% increase in service and parts. Earnings before taxe is increased 106% to $48 million and the return on sales was 6.7%. The Class 8 commercial truck market remains very strong and during the third quarter, North American Class 8 net orders increased 28% and the backlog increased to 179% to 279,000 units, representing a 13-month supply. Based on the current industry forecast, retail sales are expected to increase over the next two years and provide tailwinds to our commercial truck and truck leasing businesses.

Turning to Penske Transportation Solutions, we own 28.9% of PTS which provides us with equity income, cash distribution and cash tax savings. PTS currently operates the fleet to over 350,000 vehicles. For the nine months ended September 30th, PTS generated $8.2 billion in revenue and $949 million in income or a 12% return on sales. In Q3, PTS generated $2.9 billion in revenue and income of $409 million or a 14% return on sales. As a result, our equity earnings in Q3 increased 83% to $118 million. Our full service leasing and contract sales were up 8%. Our commercial rental revenue was up 51% and our utilization hit 88% with an additional 14,000 units on rent. Our consumer rental is up 27% and our logistics revenue increased 27%. Our gain on sale of used trucks is up 140%, as a strong freight environment and a supply shortage of new trucks is certainly driving a demand for used vehicles.

I now would like to turn the call over to Shelley Hulgrave, our Chief Financial Officer. Shelley?

Shelley Hulgrave -- Chief Financial Officer

Thank you, Roger. Good afternoon, everyone. Looking at the PAG balance sheet and cash flow. The balance sheet remains in great shape. At September 30th, we have $119 million in cash and we ended the third quarter with over $2 billion in liquidity. When looking at our capital allocation, we maintain a disciplined approach that focuses on opportunistic investments across both our retail automotive and commercial truck businesses, capital expenditures to support growth including our first half growth strategy, delivering a strong dividend to our shareholders, reducing that whenever possible and share repurchases.

In fact, year-to-date, we have repurchased 2.5 million shares representing approximately 3% of the total shares outstanding. Year-to-date we generated $1.3 billion in cash flow from operation. We invested $157 million in capital expenditures, including $18 million to acquire land for future CarShop expansion. Net capex was $84 million. At the end of September, our long-term debt was $1.4 billion. We have repaid $922 million of long-term debt since the end of 2019.

In addition, we have either repaid or refinanced our senior subordinated debt to lower rates while lengthening the term to take advantage of current market conditions, which has contributed to a $34 million reduction in interest expense so far this year. These initiatives have lowered our debt to total capitalization to 27%, compared to 37% at December 31st and 45.6% at the end of 2019. Our leverage ratio fits at 0.9 times, an improvement from 2.9 times at the end of 2019. At the end of September, our total inventory was $2.6 billion, retail, automotive, inventory is $2 billion, which is down $937 million from December last year. We have a 19-day supply of new vehicles. Our day's supply of premium is 22 and volume foreign is 9. We expect the current supply challenges coupled with strong demand to keep our new vehicle supply at low but manageable levels. Used vehicle inventory is in good shape with a 40-day supply.

At this time, I will turn the call back over to Roger.

Roger Penske -- Chairman and Chief Executive Officer

Thank you, Shelly. Moving onto our digital initiatives. We continue to grow, expand and enhance our digital footprint including the introduction of new tools and technologies to offer our customers a hybrid customer-driven shopping model. Depending on their preferences, customers can purchase either fully online, in-store or any combination of the two. We will also deliver vehicles directly to a location desired by our customers. As part of our omnichannel customer experience, we strive to be a leader and online reputation including online customer reviews and star ratings on Google. Looking at our other digital tools, we retailed 2,550 vehicles or 4.3% of our U.S. unit sales and 14% of our customers use preferred purchase and their buying journey. Using the Sytner by-on tool in the UK, a customer reserve a car for 99 pounds, apply for financing, receive insta credit approval, obtain a guarantee price and pay online. During the quarter, we sold 3,700 units using this platform.

When you combine all of our digital tools, including new technology available at CarShop, a customer may perform any part of the transaction online or may use these tools to shorten or visit to the dealership. Looking at corporate development, in addition to the 220 million of year-to-date share repurchases, we completed acquisitions totaling $600 million in annualized revenue through September 30th. In October, we acquired the remaining 51% of our Japanese-based joint venture of premium luxury automotive brands, which will add $250 million in consolidated annual revenue and we have another $300 million in annualized revenue of deals in our pipeline that we expect to close either in the fourth quarter or early in 2022.

We also opened up a new Porsche dealership in Washington D.C. earlier this year and we have three other open points under construction. We increased our CarShop locations by five and expect to open one additional location by the end of the year, bringing our total to 23 locations. We remain on track with CarShop to retail 150,000 in unit sales and generate $2.5 billion to $3 billion in total revenue and our $100 million of EBT by the end of 2023. As we look across our diverse portfolio of businesses, we continue to target organic and acquisition growth, as well as further operating efficiencies to continue to grow and expand our businesses.

Before I close, I'd like to congratulate the 35 U.S. dealerships that were named by automotive news to the 100 best dealerships that work for listing. We had more dealerships on the list than any other automotive retailer, including six of the top 10, 12 of the top 25 in the 2021 ranking. Our Audi of charge stores ranked number one in the country. Additionally, seven PAG dealerships were ranked in the top 10 nationally, including the top three places for their efforts to promote diversity, equity and inclusion. We're honored by these accomplishments and are extremely proud of our team for their commitment to drive the passion and the efforts in working together to be one of the very best.

I'm also pleased to announce the Penske Automotive Group was ranked first in the listing of U.S. public dealerships teams in the 2021 automotive reputation report published by reputation.com. In closing, our business remains strong and our record performance demonstrates the benefit of our diversification. I'd like to thank our team for their outstanding results and producing all-time record year for Penske Automotive Group. Thank you again for joining us on the call today for your continued confidence in PAG.

At this time, I'll turn it back over to the operator. Thank you.

Questions and Answers:

Operator

[Operator Instructions] Your first question your first question comes from Rick Nelson with Stephens Incorporated. Your line is open.

Rick Nelson -- Stephens Incorporated -- Analyst

Thanks a lot. Good afternoon, Roger, Shelley, and Tony,

Roger Penske -- Chairman and Chief Executive Officer

Hey, Rick.

Rick Nelson -- Stephens Incorporated -- Analyst

So, I guess to start, it's has been less -- so we've seen some major deals across the landscape announced recently. PAG has been less active and have been strengthening the balance sheet quite a bit. I'm curious year-over-year, the M&A environment, the multiples and the pipeline for PAG?

Roger Penske -- Chairman and Chief Executive Officer

Well, I think it's been an active marketplace, Rick, certainly with some large deals taking place across the automotive retail space. As we know, there is 18,000 dealerships and 32,000 franchises, so it's a big sandbox obviously. I think fragmentation provides opportunity for consolidation. With the investment required today, I think there is a number of smaller dealerships will become available. I think the deals that we see. the bigger deals are expensive and many of them require capex and also then would provide some input from the standpoint of framework agreements with the manufacturers. And basically over the last 12 to 18 months, I think we've looked at our balance sheet, we've looked opportunistically things that we could buy and invest in and I think you've seen that with the roughly $850 million of revenue that we've completed as of today with another $300 million under contract. We've a growing CarShop organically. We have added six locations. We have, as I mentioned earlier in my remarks, three dealerships under construction are new points. And I think what we will do over the next 12 to 18 months is look at growing probably at about 10%, that's 2 billion a year and that would be divided not only on a same-store basis, but also an acquisition. And at the moment, we see the opportunity from the commercial truck standpoint, that these multiples are quite a bit less than the retail auto and straight-line who is our lead OEM looking at consolidation, we're taking advantage of that. As we go forward, when you're looking at businesses, that are returning over 6% on sales. So I think that at the end of the day, we'll will continue our capex from a capital allocation and Shelley mentioned dividends and share repurchases. But we're going to be opportunistic. We certainly are not getting out of the retail auto business for sure and our commitment to CarShop to grow that I think is key with our mission that we have to reach 150,000 units by the end of 2023. So I think the deals that are done are great for our peers and to me, it just shows you the opportunity and the profitability in this business.

Rick Nelson -- Stephens Incorporated -- Analyst

Thanks, Roger, for that color. Also like to count the inventory, supply new 19 days, any visibility at all into future flows? Do you think we're at a low watermark here with inventory? Can we start to climb?

Roger Penske -- Chairman and Chief Executive Officer

We were 12 days here in the U.S. and as you look at the international had it all together to get to our total number, I've had conversations as late as yesterday talking about inventory going out. I think we'll see in the premium luxury side, we'll see some opportunity where more vehicles coming in November, December, but it's a smaller amount, and quite honestly, I mean it comes off the truck is sold or selling into the pipeline, and I think we're going to see that for the next 12 months. I don't think the supply chain is going to get fixed. And the OEMs are prioritizing the models which were they make the most money, we see that in the UK. Market was down 33% there lately. And when you look at that, it's not because there's not demand, but it is not building the small people cars because they don't have -- they don't get the margin on those. So I think there is different levers at the OEMs are pulling at this point, but I think it's going to be business as usual here, tight inventory, all the dealer groups, were all looking at ways we can sustain our customers were looking at the finance companies and leasing companies that to extend leases. So we can keep our customers stickier with us as we go forward and being able to order cars for them when they are available. So, at the moment, I think the premium Luxury people and everyone else are focused on supply chain and are building cars, you don't have some of maybe the additions and accessories that we normally would have. But overall, we outperformed the market here really looking at the market was down 13 and we were only down three. So we feel good where we are and I think that the market will certainly be a little choppy here for a while.

Rick Nelson -- Stephens Incorporated -- Analyst

Very helpful. I'll turn it over to others. Thanks and good luck.

Roger Penske -- Chairman and Chief Executive Officer

Thanks, Rick.

Operator

And your next question comes from John Murphy with Bank of America Merrill Lynch. Your line's open.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Good afternoon, Roger, Tony and Shelley. Thank you for the comments here. Just a first question and following up on on Rick's first question on capital allocation, I mean, some of the other dealer groups are being much more aggressive and actually taking on leverage and right now you've taken down leverage by repaying debt, but you're allocating capital toward growth. So I'm just curious if you can maybe just give us a quick summation in that 12 to 18-month goal of 10% revenue growth, how much of that is same-store and how much of that is acquisition? I am curious if you decided to get more aggressive with the balance sheet, curious if you consider doing that, where you think the capital would be allocated? And, are you kind of loading up here for something bigger or a better opportunity. I mean, what's it you've the prices versus other dealers that we cover that are kind of laying it out on the balance sheet to put it politely?

Roger Penske -- Chairman and Chief Executive Officer

Well. Let me say this, again we're diversified, so we've got a number of areas that we can actually apply our capital and I think from a capital allocation perspective right now, we're looking at the cost of acquisitions. There is no question on the commercial side. Truck side, we see that is certainly an opportunity for us, I mentioned it earlier that Freightliner is positive about us growing. I think from a growth standpoint in the 10% I talked about, I think, look at 50:50 just keep it simple and there is no question that when you look at our liquidity, we're at about $1.2 billion plus we've got $100 million of cash. So we're in a great position, nothing out on our credit lines. At the end of the quarter, we have our two bonds, which is roughly a $1.2 billion, those are six years, so I think before they're paid off and 375, so the rates are good and we have some mortgages of a couple of hundred. So at the end of the day I think we're in great shape. But from a standpoint, I'm looking at the market right now with the supply chain interruptions, not knowing more of these multiples are going to go, because I don't think when you're looking at that pricing. Some of these deals are looking at a trailing 12. You're looking at probably the biggest market and most profitable market we've had in many years. So I think I want to stay keep by leverage down and my opportunities in front of us, we can move right away and we could lever up 2.5 to 3 if we wanted to do for a big deal, but I have nothing right now and I would say that we're in that mode, but we get a chance to look at these in the past, we passed. And I think we'll be very selective and if we have areas where we can add on where we have scale and consolidate. We will be in there with a big number, but it's a moment, I think we're going to take a patient look and try to understand with this market is going to bring us that over in the next 12 months.

John Murphy -- Bank of America Merrill Lynch -- Analyst

And just a follow-up to that, I mean if you think about 5% growth via acquisitions over the next 12 months or so, I mean, is that, is that a kind of redeployment you think would be something we should think about go forward beyond that or because you're taking leverage down that might be somewhat conservative? And then over time, as opportunities avail themselves, you've got the balance sheet firepower to go after them, that may end up premium being somewhat conservative way to think about acquired revenue growth going forward?

Roger Penske -- Chairman and Chief Executive Officer

Yeah, I would say it's conservative, and I think if we have to put a number down and work toward a number and I think that's realistic when you're looking at what our same-store revenue is from a year-to-date. And looking into 2022 and then looking at what we have projected from an acquisition standpoint, I think that's realistic. We've got these new points opening. We've got the opportunity from a CarShop perspective to grow same-store. And on the other hand, if there is a big deal out, that's how we built the company. Remember, we are in a pretty much of a buying mode early on, and I think that what we'll do to see just exactly what's available with us. I think right now when you look at CarShop, we have the ability to grow that many times over with capital and it's a lot less. We don't have the structure in front of us and framework and some of the areas that we have to deal with the OEMs and with CarShop, but I think the brand is really taken off, will appear domestically and internationally. So that's certainly going to be a focus.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Got it. And then just second question on SG&A, you've taken a lot of heads out. I'm just curious where you think SG&A costs will go? I mean, I don't know if the pipeline in absolute terms or percent of gross, that's kind of hard a lot of moving pieces, but I mean how do you think we should think about SG&A to gross or SG&A costs in total going forward?

Roger Penske -- Chairman and Chief Executive Officer

Well. I think I looked at SG&A we're with our during during the quarter and it's interesting that overall, we've taken about 8% of our people out since pre-COVID just from an overall standpoint and almost 2000 people. When you look at SG&A and our comp was up about 100 million during the quarter, that basically was based on variable comp and the margins that we have, but we look at SG&A will probably be in the low 70s, we're better than that today, we've come down from 77, but I don't want to mislead anybody. I think the growth is driving a much better looking number that might be on a going forward basis, but I would say low '70s.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Got it. That's helpful and then just lastly, I mean I appreciate the details on digital initiatives, and I'm just curious if you could talk about a little bit what you're doing with Cox now, because that's a much newer initiative? But also as you think about that and your other efforts and how they ultimately will dovetail with some of the efforts of the automakers that are kind of trying to create a digital overlay and interaction with the consumer, which is almost analogous or similar to what a lot of dealers are investing in, just curious how you think one way you're doing near term with Cox into longer term, how do these systems ultimately interface, interact or maybe compete with what the automakers are doing some expansion there, that's pretty heavily invested as well in the digital efforts?

Roger Penske -- Chairman and Chief Executive Officer

Well, I think that we kind of have a hybrid approach really. When you look at it, we got third party sites, we got the OEM digital sites and then we're also using social media. But at the end of the day and you look at the Cox piece, we spent about a year or so with Cox. And I think with you, anybody use product at all at this point, it's excellence. We only have 2000 units on the platform right now, because it's very much in the early stages, and we've done about 300 units of sales and support, thesee are people getting off the site and moving into the dealership or directly all the way from end to end, which we think is a good start. With very little issue from a CSI perspective, we've got a lots of compliments on that platform. But I know Cox has got -- they are looking at it, they're watching at it. It's very important to them that is successful. But on the other hand, one of the things that I've cautioned our people, we see all these opportunities, but probably the thing that I want to do most is partner with the OEMs because they're all rolling out an e-commerce platform. So it's going to be part of your relationship is like your floor plan, it's like some of your financing. I think you're going to use their platform and today Toyota has Smart Pass, and Lexus has Monogram in many as anywhere. So these are all in a position today that I think we got to take a good look at and we're in the process of signing up for those as we go forward. So to me, I think that's going to be key, and I think the Internet sales are going to be key, but we're still going to have people because the premium luxury brands that we have, we're going to come in and kick the tires for sure, but I think the omnichannel certainly is just not selling vehicles, you think about service appointments, online payments, this is key. We had today between our BDCs and our online service appointments over 500,000, when you look at that in the quarter and the online payments continue to grow. I think we collected almost 50 million during the quarter on online payment. So, to me, this is key because average payments almost a $1,000, so we're using this online channel obviously for more than just selling new and used vehicles.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Great, thank you very much.

Roger Penske -- Chairman and Chief Executive Officer

Thanks, John.

Operator

Your next question comes from Stephanie Moore with Truist. Your line is open.

Roger Penske -- Chairman and Chief Executive Officer

Hey, Stephanie.

Stephanie Moore -- Truist -- Analyst

Hi, good afternoon.

Anthony Pordon -- Executive Vice President of Investor Relations and Corporate Development

Hi, Stephanie.

Stephanie Moore -- Truist -- Analyst

I wanted to talk a little bit you did, I'm just what we're seeing from these underlying trends on the other retail side, is supply chain disruptions, but maybe you could touch a little bit on what we're seeing on the commercial truck side in the freight environment, obviously having a nice benefit to both your JV as well as the commercial truck retail business right now, but maybe you could talk about the longevity you expect at some of these trends as well as maybe some of the positive attributes that might come out as a result of this even at this environment, whether it's on pricing or he used truck market and anything like that? Thank you.

Roger Penske -- Chairman and Chief Executive Officer

Well, I think we are going to go back a little bit. As you know we have electronic logs now for drivers and that was instituted here several months ago and what happened where people are running to log books and being able to run maybe 12 to 18 hours a day. They are not able to do that now without breaks and what that's done, that's certainly in a position that has created more driver requirements and yet we can't get drivers right now. And with that, there is a shortage to move goods and 85% of the goods are moved by truck here in the U.S. And from my perspective, we see the truck business is core. When you look at the demand with the OEMs, almost a 13-month backlog, that's for heavy duty from the standpoint of 279,000 units at this point and that's going to drive this business for the next 12, maybe even 24 months and that's what's driving the used truck prices up, because today most of the fleets can get their new trucks right now, so they're running their old trucks, maybe another five to six months, and that's also helping drive this used truck value, but I don't see it slowing down. And to me right now the biggest issue is the number of trucks that are sitting at these OEMs without parts. And I know Freightliner right now is making a big -- having a big focus on completing the trucks that are on the ground, which will help us, and I think that's going to take some of this backlog down. But based on what we're hearing, the first quarter will probably going to end up be delivering trucks, it should have been delivered in the fourth quarter, so that's going to push this whole supply chain out at least 90 to 120 days late from where it should have been. So I see it obviously being a positive for us from the standpoint of our rental business on the truck leasing side because people need extra equipment and that's the business we're in its commercial rental.

Stephanie Moore -- Truist -- Analyst

Absolutely. That's really helpful. And then I think over the last year really seeing the strength whether -- and the capital allocation, whether through purchasing shares, obviously reason the dividend, debt pay down. As we look forward, I think opportunistic M&A is hard to come up on the call, but where do you stand in terms of continued debt pay down, share repurchases, as we look out for the next 12 months?

Roger Penske -- Chairman and Chief Executive Officer

Well. From a debt pay down perspective, we really have mortgage debt that we have that's variable that we can pay some of that down, which we would. And I think we've got dividends, which we continue to grow the dividend base and from a share repurchase perspective, that's going to be something that we have 70 million. Right now we've authorization from the Board and we just really moved that to 250 back in July. So we'll sit with our Board in December and we'll look at that allocation going forward. So we've got a share buyback, we certainly got M&A, which we've talked about strategically maybe from a commercial truck perspective opportunistically, when we look at into retail automotive side, and then we're going to absolutely develop and invest in the CarShop part of our business. So I think there's plenty of areas to use our capital, but again, we're going to keep our leverage where it is. And then if there is a big deal, we can step up. We don't need to go to the market for extra capital. We have a 1.2 billion to 1.3 billion right now available from the standpoint in our credit lines and that's without any other -- leverage of any other assets. We only got about 24% of the book value of our real estate being green mortgages at the moment.

Stephanie Moore -- Truist -- Analyst

Great. Well, thank you so much as always.

Roger Penske -- Chairman and Chief Executive Officer

Thank you.

Operator

Your next question comes from Mike Ward with Benchmark Company. Your line's open.

Mike Ward -- Benchmark Company -- Analyst

Thanks very much. Good afternoon, everyone.

Roger Penske -- Chairman and Chief Executive Officer

Hey, Mike.

Mike Ward -- Benchmark Company -- Analyst

I mean, is there a way to rank the capital requirements when you look at these growth investments, whether they're open points, truck distribution, CarShop, M&A, is there a way to rank which ones are from either higher with lower low to high as far as capital requirements when you do this?

Roger Penske -- Chairman and Chief Executive Officer

Well. From a CarShop perspective, I'm going to just take it as they come to mind that we have significantly less investment in a CarShop location. We're just opening one in Phoenix, just opened one this week, which probably the investment is about 12 million total and the one over in New Brunswick was about the same. And I think when you look at those locations and the returns, there are much greater than they would be if we had to build a say a premium luxury store in the same place, but I think it's lower investment. When you look at return on sales, we're in the, say, 2%, 3%, 4% on the retail side. I think from a truck perspective, commercial truck is looking at somewhere between 5% and 7% return on sales, so that certainly would become also a priority for us. So the opportunity also, which we haven't talked much about is in Australia, as we start to grow that, continue to grow that business. But as we have defense, we have big power gen capabilities there. We have our -- certainly are on a highway and our mining business is there and we continue to invest in equipment and facilities out there and today, we have some single source contract with the government on defense going forward. So our capabilities there to get more vertical with the government will be certainly an area we would spend some money on or to have those long-term five and 10-year contracts and those are quite profitable also.

Mike Ward -- Benchmark Company -- Analyst

So, with your joint ventures bringing them in from Japan, does that open up additional opportunities in Japan with your partners?

Roger Penske -- Chairman and Chief Executive Officer

There is no question. We really wanted to know, Mitsui a partner of ours. We're a big player with Toyota and Honda. So we wanted to be in that market, we made it, we did a joint venture with Neikoramki [Phonetic], there are a number of years ago, and what we wanted to do was get our feet wet there understand, what was the requirement from accounting perspective, from a controls and risk. We've operated in that business now for probably about five or six years where they are paying a distributor for all of Japan, we're a big BMW dealers there. We have Rolls-Royce and Ferrari right at along with many, but I think when you look at it, the OEMs have come to us a number of times wanting to us add to our platform and we would expect to do that with the management team we have in place. Our former partner is moved to non-Executive Chairman, so we still have some oversight with him. But we have a gentlemen who has been there now for four years really learning the business came from the OEM side in America and foreign Japanese shows the Japanese wife and he has really done a great job. So we think we're in a position with the controls in place now and will go forward that will be a growth area for us.

Mike Ward -- Benchmark Company -- Analyst

A couple of questions for Shelley. Shelley maybe starting our first, when you look at your debt ratings and you're right on the cusp of investment grade. Is there any plan or does it benefit you to get moved up to investment grade or is it just a relevant?

Shelley Hulgrave -- Chief Financial Officer

No. Given that, thanks to our balance sheet, we can certainly have those discussions with rating agencies, like you said, S&P upgraded to BB plus in May and we're BA1 with Moody's, so just below investment grade right now, it's not a priority for us, but it never hurts for us to have those discussions.

Mike Ward -- Benchmark Company -- Analyst

Numbers.

Shelley Hulgrave -- Chief Financial Officer

Yeah. Our lease adjusted leverage ratio is now at 2 times when the requirement is 3 times, so we do have some questions, as Roger had mentioned earlier. Clearly there is upside from an interest rate perspective, probably about 100 basis points on future fund of rings.

Mike Ward -- Benchmark Company -- Analyst

[Iindecipherable]

Shelley Hulgrave -- Chief Financial Officer

Yeah, we're just evaluating the potential policy restrictions. So as we looked at our capital allocation strategy, we wouldn't on a risk of potential downgrade, but we wouldn't want to pass up a significant opportunity either.

Mike Ward -- Benchmark Company -- Analyst

What is the impact on cash flow as inventories replenished over the next year or two?

Shelley Hulgrave -- Chief Financial Officer

Well, We're part of the majority of our inventory purchases like -- of the impact is really eliminated, and we're not expecting, as Roger mentioned, a quick return team inventory, if at all to prior levels. So we continue to see a build up of pent-up demand, particularly with the lease returns starting to come off those stronger years and as we've seen the production returns will be gradually very minimal impacts.

Mike Ward -- Benchmark Company -- Analyst

And just one last one. Some of your peers are starting to get into the finance business. Given you're generating so much cash and it looks like it's going to be at similar levels at least through the end of '22. Are you considering that at all or if you looked into though the plus and minuses of starting a finance on?

Shelley Hulgrave -- Chief Financial Officer

We have from time to time evaluated those pros and cons, Mike. The decision typically comes down to the return on capital, and as we've talked about, we are experiencing some pretty great returns on PPL or PPG acquisitions and even our recent Mercedes store that we acquired here in April. So, plus the majority of our transactions on the premium luxury side or in the leasing side. And we have an 80% penetration rate with our new vehicle sales. So when you look at that in our small shop business. I'm not sure starting to the finance company really makes a lot of which this right now.

Roger Penske -- Chairman and Chief Executive Officer

Hey, Mike, we've looked at it. In fact, it was a discussion item at our latest strategy meeting. We can borrow money like the banks can. in order for us to get the kind of return we want, we're going to have to go down in credit rating in order to be able to attract the kind of returns we want and then it starts to burden your balance sheet. Certainly we can securitize over time, then the lease counter the accounting requirements, we have to take in the income over 30 months, 40 months or 16 months depending on the term of the contract. So I would say right now when you look at our subprime business, it's only 6%. So I think we're in a good position. It's something we continue to look at. We've seen other people take that on and look we're different and I think that will probably not be getting into that business at this particular time.

Mike Ward -- Benchmark Company -- Analyst

And just a follow-up earlier, when you talk about these open points and I think you have three open points, is that something we can expect to see more up and that's not just U.S., right that's -- it's Europe as well.

Roger Penske -- Chairman and Chief Executive Officer

Right. What we're good at obviously we had open points in CarShop, which we can designate those. We've been in it. With the OEMs to get some, we've got two open points in Austin. We of course had the open point and a portion, we got a couple open points in the UK. So I wouldn't say you're going to get through for every year. But where we have scale and where we have proven to be a good operator, we've had this opportunity, we apply for those and we've been successful. So we see those is a good way to grow. We're growing the way as long we're able to build purpose-built facilities that meet the CI and not have to jump into a bunch of corporate identity when you're buying a bunch of stores that are not brand new. So we see that obviously as a positive.

Mike Ward -- Benchmark Company -- Analyst

Thank you. Thank you very much.

Roger Penske -- Chairman and Chief Executive Officer

Thanks, Mike.

Shelley Hulgrave -- Chief Financial Officer

Thanks.

Operator

Your next question comes from Rajat Gupta with JPMorgan. Your line is open.

Rajat Gupta -- JPMorgan -- Analyst

Great. Thanks for taking the question. Sorry to ask you once again on capital allocation, just balance sheet leverage. I mean you're going to be generating a significant amount of free cash flow over the next year or so, given this elevated margin profile. It doesn't look like the M&A multiples and the automotive retail side see attractive. You already have some capital committed for CarShop, which is kind of well understood. Given like we are in this slide on the [Technical Issues] as longer, would you consider like a big buyback? You have to have like a turn of leverage to do like you may be in close to $1billion given you're generating more than gave $800 million or so free cash flow. Just curious to know, what's your take on that iand would you consider doing a bit buyback in the interim given this extra level of free cash flow? And then I have a couple of follow-ups. Thanks.

Roger Penske -- Chairman and Chief Executive Officer

Well, I think share buyback is something that we discuss with the Board and as I said earlier that we'll have that discussion in our December meeting, that's always an option for us on a going forward basis. We've been pretty much consistent increasing our dividend, a penny a share as we've gone forward over many quarters and we had 250 million of buyback authority. We thought when you started looking at options for our capital, that share buyback was certainly prudent during the last quarter and all those same conditions could take place in the future and that would be reviewed by the Board and we make those decisions at that time.

Rajat Gupta -- JPMorgan -- Analyst

Got it. And just on shifting gears to GPUs. On the new vehicle side, I'm assuming that you know the actually GPU continue to get better through the course of the quarter, you're likely exiting the third quarter with a higher run rate than your average. Just based on what you're hearing from OEMs, the supply, can you sustain this kind of like high 5,000 number for a few more quarters or do you see this coming back to more normal, not normal, but like -- do you think like third quarter is the picture for you?

Roger Penske -- Chairman and Chief Executive Officer

Well, I think I've had that question before. And when I look at the entering the quarter and then exiting the quarter, there is no question that growth is -- new vehicle growth is went up month-to-month. July, August and September also our huge went up. I think at the end of the day, when you look at MSRP, that's a manufacturer sales price, suggested sales price. There are some people who are selling above that. I think that that's very dangerous territory right now because what it does your customer over long period of time, we really don't know. So I think that on a used car side, we're probably closer to the top and because we have nothing on the ground and you're selling into the pipeline, you're going to continue -- you're going to continue to hold good margins now whether it's within $100 of what we have today. I think that the sustainability of the growth is right now be depended on supply.

Rajat Gupta -- JPMorgan -- Analyst

Got it. Got it. That's helpful. Thanks for all the color. I will jump back in queue.

Roger Penske -- Chairman and Chief Executive Officer

Thank you.

Operator

[Operator Instructions] Your next question comes from David Whiston with Morningstar. Your line is open.

Roger Penske -- Chairman and Chief Executive Officer

Hey, David.

David Whiston -- Morningstar -- Analyst

Hey, everyone. Thank you. First on the truck space. Roger, you talked earlier about there's -- it's just taking too long for new trucks orders at Matt, so is that purely chip that shortage or is there are some supply chain issues on top of that that are more of a problem?

Roger Penske -- Chairman and Chief Executive Officer

Yeah. Listen, people don't realize that their airfreighting tires now, a lots of things other than just chips on the heavy-duty truck side. So I think the key thing here is we look at it, when you look at the manufacturing businesses and plants are losing our people have lost people and trying to crank back up again, there's some human capital requirements at their meeting and again they have to be trained. I talked to one OEM the other day and I said any one day they could be down 25% of their workforce. So how do you run your plant and a quarter people won't show up on Monday morning, so I'm not saying this is any particular truck OEM, but this is pretty much what you'd see in the marketplace. But right now, there's a big demand for heavy and medium-duty trucks and the suppliers that there and quite honestly, we've seen the impact of that on our Penske Transportation Solution business, because with our 88% utilization rate on our tractor base, which is up 14,000 and when you look at total units, it's amazing. And we don't see that slowing down really, some of the consumer rental, which is the one way, that will come back probably 15% to 20% in Q4, but overall I think you're starting to see the deliveries of the heavies are going to be pushed out into Q1 and Q2 and it's a strictly availability of all components. And when you have tens of thousands of units sitting on the lots of the OEMs unfinished, they've got to focus on those before they build more new trucks. They just don't have the space.

David Whiston -- Morningstar -- Analyst

Thanks, that's helpful. And then in the UK, consumers are dealing with a lot of shortages, particularly even if you all of that causing a lot of havoc your stores and in terms of people not wanting to buy a vehicle?

Roger Penske -- Chairman and Chief Executive Officer

We don't -- I don't see that. I think electrified vehicles have gone up and If you look, I don't have the numbers right here in front of me, but there is no question that demand is still strong and there has been a movement, a bigger movement to electrification, maybe some might have to do with the shortage of fuel, but the big issue there is drivers, to drive some of these big rigs because a lot of them went back to Western and Eastern Europe. When COVID hit haven't come back, in fact, I think Johnson was giving some permit for 5,000 people to committed drivers or to drive some of this equipment, which certainly has had an issue hybrids seem to be, what's the hottest sector in the UK right now, because that gives you the opportunity to go into cities like Los Angeles and Birmingham and places like-and London and Birmingham where the hybrid vehicle and most people have to pay a tax when they buy an ICE engine and if you have electric vehicle, you pay no taxes, and the company car that's a big factor from the standpoint of what they pick. So that's also driving electrification.

David Whiston -- Morningstar -- Analyst

Okay. And PTS, the press release cited operating expense reductions, where are those primarily coming from?

Roger Penske -- Chairman and Chief Executive Officer

Say that again for PTS.

David Whiston -- Morningstar -- Analyst

Yeah, there is an operating expense reduction cited in the press release. I am just curious if that was coming from operational moves or headcount reduction?

Headcount. It's efficiency and headcount across our business. We've got -- Roger mentioned, we're down about 2000 people or 89%, David, across our business, it's not just -- it wasn't specific the PTS. it was specific to our overall business. Okay. And last question, I'm asking everybody this, are you seeing any change compared a few months ago whether it's CarShop or on the traditional side. Our consumers just getting fed up with the shortages and just saying I'm not going to get accused, I'm going to wait till you have more new inventory or conversely our people more desperate?

Roger Penske -- Chairman and Chief Executive Officer

I think one of the thing is on the used side is the prices are getting so high. It's almost like sticker shock that can almost buy a new car, but of course we are not available. So some people might be sitting on the side in order to get pricing right and then availability of new vehicles too to have another option. That's where I'd say right now.

David Whiston -- Morningstar -- Analyst

Okay, thank you.

Roger Penske -- Chairman and Chief Executive Officer

All right, David. Thank you.

Operator

[Operator Instructions] There are no further question at this time, I'll hand the call back to Roger Penske.

Roger Penske -- Chairman and Chief Executive Officer

Thank you, Jerome and thank you, everyone for joining us today. We will see you next quarter.

Operator

[Operator Closing Remarks]

Duration: 52 minutes

Call participants:

Anthony Pordon -- Executive Vice President of Investor Relations and Corporate Development

Roger Penske -- Chairman and Chief Executive Officer

Shelley Hulgrave -- Chief Financial Officer

Rick Nelson -- Stephens Incorporated -- Analyst

John Murphy -- Bank of America Merrill Lynch -- Analyst

Stephanie Moore -- Truist -- Analyst

Mike Ward -- Benchmark Company -- Analyst

Rajat Gupta -- JPMorgan -- Analyst

David Whiston -- Morningstar -- Analyst

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