David Cosper - Vice Chairman, CFO
C.G. Saffer - VP and CAO
Sonic Automotive Inc. (SAH) Company Presentation Conference December 4, 2012 8:10 AM ET
Thanks for joining us for the second presentation this morning and it’s been a very good conference, but I know a long one, so I appreciate everyone’s attendance. With us today is Sonic Automotive. And for those who don’t follow, auto retailer industry, I think you’ve learned that Sonic is one of the best players in that sector. The sector itself has performed extremely well over the last five years, including during the downturn. It’s a very good business model. I think Sonic does a good job of leading in the industry. And what I like to do is introduce David Cosper, the CFO, who will be our speaker today and C.G., the VP and Chief Accounting Officer sitting to his left. We’re going to try to do about 20 or 25 minutes of prepared remarks and [then will] Q&A the better.
So without further ado, I turn it over to Sonic.
Thanks, Doug. I’m David Cosper. Welcome everybody. I’m glad to see you here this early. That was quite a reception last night, this place is incredible. We found a room. I’m going to take it through a few slides, give you a little bit of background about our Company and what we’re up to. Then we can – I can sell your car, we can talk about our business or anything you would like to do.
This is our strategic focus; it’s the priorities of our business and largely unchanged for the last four, five years. It’s really three things. One, grow the base of business and that’s really about getting the best returns on the existing assets we have. We have not been acquiring I think pretty much the – of course we grew through acquisition, roll up like everybody else in our sector, but we can’t put the breaks on that for a number of years to get the best returns we can. And I will talk about that a little bit. Own our properties, net moving from the sale lease back model to owning, actually on our balance sheet the stores with mortgage funding. And then improving our capital structure, we worked hard on this since the financial crisis, which was very difficult thing if you recall. And we made great progress, show you what our balance sheet looks like.
On the base business, this is a picture of our ultimate goal and the top there is a – better customer experience. Cars are awesome. I love them, people love them. Thank god, they like to buy them and it’s a horrible process. You got to have clean teeth’s; you don’t like to go to the dentist. People don’t like to go to dealerships. We want to totally change that buying experience and make it customer centric.
When you go into a dealership, you already know the pricing, you know the model, you know the color, you know everything about it from being online and whatever other research is done. Yet we will make you sit there three, four hours. How can that be? We want to totally change that model over the next couple of years and get it to a one-hour experience in and out. And to do that we started with a culture that’s on the very bottom, because it’s a tough business, turnover is rampant. Our turnover hit 65% a few years ago, how can you get a good experience with changing the guard several times a year? You can’t.
So we focused on people. We’re paying them, we’re training them or developing them, they were surprised at first that we cared about them, but it is working. We’re three, four years into it. We have a play book, in all that is how to best processes we would like you to follow and we will teach you and help you make money, instead of yelling which is the traditional model in our business. And then we got a technology aspect to it with analytics, iPads and what not to help make the experience better for the customer.
And we’re seeing signs of great improvement; I will show you in a couple of slides. This is owning our properties quick slide. Four, five years ago we own nothing. Today we’re about 23%. Our total portfolio is a little over $1 billion of building and real estate. So we’re $230 million something like that that we own. Over the next few years as leases mature and we take other actions, we will be up around 44%. We don’t have a real target here, but we would like to own the things that we would like to own.
Its better cost financing, conceptually you’re swapping a lower cost mortgage for a lease. So there is not a huge cash outflow, 20%, but you’re building something on your balance sheet and manufacturers require you to invest and reconfigure the styling and we want to put a new roof on our house, not somebody else’s home, that we are running. So that’s the thinking here. It’s a winner for us.
Now move into our debt and here is a summary of our debt and we’re little over $400 of public debt and then you can see the mortgages at 187 today, little over $600 million in total. But we think of mortgages, when people ask us why are you putting on a lot of debt, we really have the debt with a lease. This is what I call inside good debt. Leases are bad debt. That’s all I think about. You will see that circled number the 5% converts that we just recently took out, I will talk about that in a minute and we funded that with a 7% bonds there, $200 million.
Liquidity is probably the best state we’ve ever been in, as a Company little over $200 million there. So we’re very comfortable with it. We have no borrowings on the revolver haven had for a long time. We don’t need it. Plenty of cash, we’re generating cash, so we have a good liquidity position and project that going forward.
This slide shows what we did with the convert and it was an interesting transaction. This was a convert that was in the money, highly dilutive, we have roughly 53 million of real shares and we had another 12 million at one point of shares with this convert. That’s massive dilution. I think at one point we were the most highly shorted stock in the New York stock exchange and we just wanted that thing out. It’s something we had to do to get through the crisis and so we targeted to take that out and we’re buying it in the open market, expensive and slow. Then we took it out with a $200 million financing in July, August timeframe. And we use the money and actually issue shares, kept $60 million of the $200 in proceeds and have been re-buying the 4 million shares that we issued as part of the transaction to take that out. But its out and then you see a number of years and you got five years of clean runway with really no major maturity issues at all.
Credit facility we have with a number of banks and capital finance companies be they lead this for us. It’s a good size facility, $175 million on the revolver, which we don’t use. $500 million of new car floor plan financing which we do use. And 80 million of used car financing which we don’t use at the moment, that’s one of our sources of liquidity, we just pick that off. And if we need it, we can borrow it in one day.
Favorable pricing here matures in 2016. As we get closer to that day, we’re talking with our banker this morning. We will think about what we do with that 2,018 maturity before we start thinking about renewing this facility. Debt covenants, we got a lot of coverage here. Lot of cushion, we’re in good shape on liquidity ratio, fixed charge and lease adjusted leverage ratio.
Here is the results for the third quarter and we were up about 18%. You know the car industry continues to grow. Its one of the bright spots and I think one of the reasons for that is A: people like cars, which is good and B: during the crisis they didn’t buy them, and so they got older. And now people are – the fleet age out there is the oldest, it’s been and a long time and people are starting to replace. They’re getting more comfortable – they’re more comfortable with a job in the economy and the outlook, hopefully they don’t read the paper about the fiscal cliff. But we haven’t seen any led up and in fact December is one of our – it is our biggest month of the year, which is our December to remember. For the year, I expect us to be up about 20%. Last year’s profits were up 14%. So the growth has been quite strong in our business.
This slide I really like that red line is the industry volume and it went to the lowest levels that I had ever seen in my career, in sub 10 million, it had been at 16 million – we’re back to mid 14s, I think we get 50 million something in November, it’s pretty strong. Some of that’s the Northeast recovery from the storms. But what I like about this is we’re last 12 months at 14, 2007 was 60 million, so we’re not back to where we were, but our profits and cash generation are, and there is a lot of reasons for that and I will pick up on that on the next several slides.
One is new vehicles, of course. The industry is growing, but that blue bar on the left there, 25% is higher growth than the industry. Red is the retail industry where we sell fleets the other, so including fleet is down at 15%. The fleet is going to pulling it down, but we’re beating the growth of the industry – you do that by taking market share, executing better, getting customers online, bringing them and satisfying them. And so, retail revenue was up 20% in the quarter.
Pre-owned is an area that we have really grown. It’s been a target of ours. Five, six years ago we were dead last in the sector and now we’re number one. And we think about it in terms of number of vehicles sold per month and we’re up at 87. We had a target of a 100. We were 82 a year-ago. This slide here shows you the growth that we’ve had – in 2007 we sold 50 vehicles per store per month and year-to-date we’re at 86. We had 94 on some months, when it’s a big month, depending on the number Saturdays. So we can get to 100 and this market, the used market is three times the size of the new market. The barriers to entry are different. The margins are good and it energizes the business in a number of ways. And what this slide shows is the year-over-year impact on our gross profit from being in used at growing that part of our business.
And of course when you sell a car, you get the gross on it. You also get a short at financing insurance product, warranty service contract things like that. And you also have this reconditioning. When we take a car and on trade, we will send it to our shop, make it pristine and ready for sale. And then they conceptually sell up to the front-end for the user car people, who turnaround and sell it. So this energizes every part of our business and makes very good money for us.
This is finance and insurance. The blue bar is the gross profit, total dollars and the red is the pre-unit, both are trending up. It’s a good trend. You talking about $1000 a unit its real money, its 100% margin very low risk for us. We are a provider of services. We’re not the leader in this, that many of the other publics and private groups you will see a 1,200, 1,300, 1,400 a unit. There are certain risks in doing that, related to customers and the law. As we’re highly regulated in this arena, so we got slow steady save profitable growth.
Fixed operations, it’s just the part of our business that really makes money. Its not huge revenue, but its very big growth. We really focused on expanding this part of our business, selling more out of our service lanes. Pricing more better to get customers and retain them. And even with the total units being down because the sales felt so much, we are still going to able to grow this business. And warranty is being down a lot because new car sales have been low and also the quality has never been better virtually on all the manufacturers out there and quality is very strong.
SG&A, we have – this is SG&As percent of growth and you know its two thing, numerator and denominator, the cost on the top and gross on the bottom. We are not the low cost producer. We’re investing, investing a lot in technology, a lot in training and a lot in compensation to keep our people. And it’s starting to show. Those trends are which is showing, it didn’t happen automatically. You need good people; you need good processes to keep that moving. Now where this is, if you’re not the low cost producer, you better be selling and that’s how I talk inside. You’ve got to get the gross and this past year we’re spending in public three, four million a quarter on technology. For our stores and training, they will continue into next year, but you’re going to start to see that gross take off and the spending and training slow down and that’s when this ratio really come into line. And the growing new car industry is going to help this as well.
So in summary, we’ve got a good strategy. We stayed with it, we haven’t been distracted. We are executing. Each segment of our business is improving. And in the new car industry growth is helping them of course plenty of liquidity, strong cash generation, very low refinancing risk, which I love. As we’ve had our share this is over the past few years like everybody else. I mentioned the revolvers 2016 and even that’s got some time there and first bond maturity in 2018. And again, the industry is growing, but I think our biggest opportunity is us – its continuing to execute and go towards that vision of a better customer experience where people want, they’ll drive by two or three other BMW stores to come to ours, because they like the guy, they know them, they’re taken care of, they don’t have to dicker, they get a fair price on their trade in, and they’re treated with respect and they’re in and out quickly. And I think that’s the key to our success longer term.
So, I’ll zip through that in very good time. Any questions? Yes, sir. Oops oh, sorry, okay.
Just a couple of thoughts here; Penske obviously has a different process; he must lease everything he owns. He doesn’t own anything in terms of the store base here, I’m just curious what do you think he has this season in the edge and that still seemed to have a stage for it. The other thing is, with the low cost of money here, talk a little bit about the opportunity obviously I’m just using that to get the talking point here. He continues to be doing something in acquisitions, what have you, cheap cost of money, yeah it doesn’t make sense really to build anything and then a kind of a government uncertainty that we have here. So, I’m just curious why you’re not – you don’t see that. What do you see is the opportunities out there? How much of the business is consolidated to [Mike] would really like to own and it’s with the guys like yourself, the publicly traded companies and where is the dynamics of this going because the low cost of money it seems like it should be up here, sold into franchise.
Yeah, great question. Penske is a great operator. He has a very good culture. And like us some years ago, he’s 100% sale and leaseback. I think they moved off that. I think they’re moving to own a few other stores. Everybody pretty much was sale leaseback initially, because lenders looked at us in the beginning, well there are a bunch of dumb car guys, I’m not going to lend to them, all right, until we prove ourselves and now we can get financing. And so we made the move to get mortgage financing. He puts a lot of money into his facilities and he just may have a different view on it than us. I think it improves our balance sheet. We pay back, just like a house mortgage bank we pay roughly $1 million a month in principal, so that thing is going down very quickly. And then you’ve got something on your balance sheet, and not just goodwill which is dust. This is a real tangible asset, so that’s my personal preference. My math tells me it’s a very good return, very low risk. You just swap in one bit of funding for another.
Relative to acquisitions, I think we’re the only one that isn’t acquiring. And we will acquire one day, but I think we have not gotten the returns we should have for us. I think that you’re buying these dealerships from dealers, it is not easy. It’s a complex negotiation. There can be an opportunity to overpay which syncs your returns no matter how low your cost of financing is. And probably the most important thing for us is we’re trying to build this culture and it sounds maybe a little crazy, but I came from Ford which has a culture, and in our business the culture in the retail is not very good, and ours is becoming better. And our thinking is, well we’re developing that culture in our people, in our model, in our processes, it would be disruptive to adopt a new child into our family. They won't understand us; it would be a distraction and taking our eye off the ball. Give us another two years and I would think we would easily integrate assets into our portfolio, into our family. It’ll be better at that time. We’ll be ready for it.
Do you believe in things like (inaudible)?
Yes, willing to (indiscernible) invest. I mean you submit your returns when you clock down your dollars upfront. We do have several facilities that are large like that and yeah, it’s a little counterintuitive, but we’ll own a BMW, the Mercedes store side by side and that’s a good thing. You could get your mind to think it’s a bad thing, but it’s a good thing. You attract people into that and you’re going to sell them one side or the other. So, they’re good, and he does a terrific job. His facilities are first class.
I want to jump to a real quick question on mix. How do you kind of shape your mix luxury versus middle, low kind of brands, and how do you think that aspect will look going forward?
Yeah, we’ve been largely unchanged for quite a while. We’re closed to – little, maybe a little over 50% luxury, we like that, we’re very big in BMW, it’s 20% -- low 20% of our sales, probably $2 billion in revenue for us. 33% roughly in Japanese product and the rest some domestic, not a lot of domestic, we have zero Chrysler, some Ford, some GM and a fair bit of Cadillac within that GM. So we haven’t been acquiring stores. We have shared a few that have not fit our profile which in the past used to be unheard of, but we let our Mercedes Benz store go, we let our Toyota store go, we let our platform in Oklahoma go, because it wasn’t a good use of our capital. And so, I think once we start to grow again, I don’t think we’ll move much from where we’re at. A lot of good franchise is out there, and it will depend on our appetite for risk and what we see going forward, but that’s – it’s still a couple of years off.
Do you see the trend that everyone envisions here in United States towards smaller cars for a lot of variety of reasons, expenses, cost of gas or whatever it might be which obviously is not taking place and see if we can, (indiscernible) certainly change that around pretty quick for us, but I mean like in the Europe every – all the cars are small.
The question is; do you really make money in any of those segments. Help us with that, I mean obviously the tremendous pressure to reduce the number of pickup trucks I own a pickup truck myself, so probably one of those guys [technically] incorrect, but how do you see the directional here for the business and although the fact that the luxury car business probably makes up for all that.
Yeah, it’s hard to know. There’s one thing I do know, it haven’t been in the business well over 30 years. Americans do like their product, and we’ll get our scares every now and then, but everyone is running to buy a Prius. And then something changes and you can't give them away. I think longer term it’s going to be smaller, greener. Those trends aren’t going away, but it’s a very large country, we’re not villages, and you need to get from point A to point B, there’s a lot of manufacturing and I don’t know if you use your truck for business or what.
The recreational part of the truck where it was just called that big truck, I used to have an F250, v10 manual transmission and its fun. But it’s not – I was in Michigan at that time, so it was fun in the snow. But I think that is going to dry up, but there’s construction people, small businesses and there’s going to be pickup trucks, because you need them for their business and that’s what we’re seeing now. I think in my lifetime and people are still going to like fast cars. I sat with an investor at breakfast; he just bought or had bought his son an M5, BMW, very fast car. And we were laughing about the seats.
When you take a corner in an M-series it grabs you and holds you. It grabs your mid section. It’s cool, people like that. So, I think you’re always going to have and we make a ton of money on those. We do make money on – a little bit of money on the smaller vehicles, but I think our expansion into use is also going to be an area where we can mitigate some of those other trends. Yeah, you got a little bit of balance on both sides, because there’s always going to be a market there.
Our gross on our use is about $1,600. New on average is about two grants, $2,100 which ranges from $1,000 to $3,000, $4,000.
You said the average is like [choosing] the used car business is typically the other guys was very lucrative?
It can be. We are the lowest margin used car guy out there, because we and as far as talking about it, we don’t view it just as the use margin. We like the F&I and we like the parts and service business that goes with it, so we view it as a unit, and are willing to give up a little bit of margin to get the volume, that’s how we’ve grown that volumes and energized our stores.
The journal this morning commented on a somewhat surprising spike in inventories, new cars in the U.S. Are you seeing that, and can you see that continuing, and would you be blamed as sort of on the fiscal cliff, people sitting on their hands or are you seeing it all.
We are, it’s a bit of an anomaly interestingly, because the (indiscernible) in last month which is a good run rate. For us our inventories have crept up and a lot of it is the Japanese products certainly year-to-year, because we were so low last year and from year-to-year we’re up a lot on Japanese. We need a lot of new car inventory coming into December. The last 10 days we just blow cars out. It’s a mad house. And we make a ton of money in this month. So, we’ll see after that how we’re doing.
Ironically our used car inventories is a little light for what we like, we’re down to about 25, 25 days supply which is very fast, spinning. And we’ll – when it comes to year end a lot of dealers, private guys particularly are selling their used vehicles to clean up their balance sheets for year end and that’s when we like to scoop them up. So we’ll probably see our used inventory lift in the end of the year. I think I’m slowing down, I am not exactly sure what it is, I mean the sales are good, but I wouldn’t call it a crisis in any sense, but I think we’ll know better come the first of the year after the December month.
Yeah, Japanese have built is pretty good. December to remember baby; it’s huge. Any other questions? I am wearing my BMW cufflinks, and we’ll take orders. We can make your car buying experience so easy, and I’m not kidding. Just call me and we’ll take care of you. That’s what we do.
I actually have one last question.
Okay, sorry about that.
Well that sounds very nice, (indiscernible) but will not be buying BMW for my son. If we look at organic growth, I mean that looks like the way that you guys are going to grow rather than paying up for acquisitions and I thought for a lot of automotive dealers I mean they’re very tough to deal with, so trying to buying new – so buying new business may not be easy. So for the organic growth is there certain areas of the country that you think you can expand these years. What type of percentage growth are we looking towards the next three to five years 2%, 8%, just a little bit of kind of color on that?
On the organic side?
Yeah. I mentioned this, but our growth I think has been pretty good. We’ve kept pace reasonably well with the pier group even though they’ve been acquiring stores and repurchasing their stock to some extent, some of them have. We grew 40% in 2011. It will be roughly 20%. I can see low double-digit for next year. We’re messing around with it, I wouldn’t run to the analyst with that number, but I still see a lot of upside in our business. Particularly on used and with the new continuing to grow in the process is being there. If I were going to invest money and if you were big in California I don’t know that I’d geographically want to expand it. It’s a complex and difficult place to manage.
Houston we do extremely well. Texas is a gold mine for us, and now we’re in the south-east, Tennessee, Georgia some of those. You might think they’re sleepy states; they’re very stable, make a lot of money, they didn’t dip down much. We can see some growth there, but again it’s a little early days for us. I think we can milk this thing quite a bit. Now look at the valuation of our stock and I know this is a dead conference, but still think that looks attractive from where we sit. So, we’ll put some money there too.
(Indiscernible) any other questions we will close it down. All right, well thank you very much, David. Great presentation.
Thank you. I appreciate it.
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