Asbury Automotive Group, Inc. (NYSE:ABG)
JPMorgan Auto Conference Call
August 14, 2013 9:05 am ET
Scott J. Krenz – Senior Vice President and Chief Financial Officer
Ryan T. Marsh – Vice President and Treasurer
Yeah, we are going to get started with our next presentation from Asbury Automotive Group. We are happy to have here with us Scott Krenz, Asbury’s Senior Vice President and Chief Financial Officer as well as Ryan Marsh, Asbury’s Vice President and Treasurer. Asbury is a retailer of new vehicles, a $4.6 billion of revenue last year. They have 100 franchises spread across the Southeast United States.
So with that, I’m going to turn it over to Scott. Scott, thanks for being here.
Scott J. Krenz
Thank you. Good morning, everyone. We will run through this presentation hopefully relatively quickly. The presentation is set in two parts; first is just sort of an overview of the Company. The second part is talking about the growth opportunities, and I think you’ll see that we have significant growth opportunities both organically and through M&A, and we’ll take you through that. One that we really don’t talk a lot about in this presentation is just operational excellence, which is really the heart and soul of Asbury.
We pry ourselves in running this company relatively well. We never say we are the best because we always believe we can do better. But I think if you look at any of the operating metrics, which are generally used to judge a automotive retailer, you’ll find that Asbury at least amongst the ones you can get, the publics will rank generally either number one and number two in each of those metrics. So the underpinning of the entire company is really operational excellence.
This is the Safe Harbor language. I’ll just go by that. Asbury is a pure auto retailer or light vehicle retailer. We believe just philosophically that that’s our business. We intend to stay focused on that business and have no intentions of wandering anywhere from the auto retail business.
We also are very much concentrated in the Southeast of the U.S. sort of from we do have a single point or actually two points in Princeton, New Jersey, but essentially from Virginia, down the East Coast then across the Gulf to Texas. Again, that is by both choice as well as a little bit of history, but largely by choice to be concentrated there. In this business to again run it well, and I’ll come to that theme of operational excellence, we found that to be able to get to the stores relatively quickly and have a presence there is important.
So we maintain a relatively compact footprint. We have no interest whatsoever in moving outside of the U.S. We believe there is a lot of opportunity still in the U.S. and in the areas where we are represented to grow without complicating the business model and bringing other things into play like currency and the other things of moving offshore.
So, we are interested in expanding and I’ll talk a little bit about that when we talk about the M&A opportunity. You can see there in the pie and I will go through it, but you can see where our revenues come from, but it is basically a southeastern company.
This is our brand mix. It is in some respect the brand mix we were dealt when the Company was put together back in the late ‘90s, but it’s also one that we’re quite happy with.
You’ll see that it tends to skew heavily towards the Japanese products. But when you talk about Honda, Nissan, Toyota you are talking about really quality companies that are putting good products on the road, support their dealer networks very well, and have great relationships with their dealer networks. We do have basically all other major brands represented in our portfolio somewhere, and fundamentally when we look at this portfolio, we think about diversification. I defy anybody here to tell me three years hence what the hot tire is going to be.
There is a lot of new product going out there, but it’s still a very much of I guess what captures the imagination of the consumer out there. So we think it’s very important to be diversified. And then, when one brand is hot another one maybe having a little bit of a aged group of products, but that will swap in a couple of years. So overall we try and maintain a diversified brand mix, but it is at this point 80% Japanese import or import and luxury is the bulk of the portfolio.
Our strategy is real simple. We laid this out very clearly as well as our capital allocation strategy late about a year ago now, and one thing we pry ourselves as a company is that when we say something we do it, and this is the strategy we are executing in everything we’ve done to-date, has been an execution of the strategy one, and I’ll come back to it, is operational excellence is the core of everything we do.
We believe that you can constantly improve what you’re doing over the last three or four years, we have moved the Company from being sort of last place in most metrics to being, as I said, very close to first place or in the first place in virtually every one of the operational metrics that you want to measure the company by, and we continue to say that is our focus, we are going to continue to drive operational excellence, is the heart and soul of everything we do.
The manufacturers view us as a good operator now, so when an opportunity to acquire a store comes up, which requires manufacturer approval, they known in Asbury they are getting a good operator, incredibly important. Our consumers, our customers know that they are being treated fairly, and are getting the good deal and so that’s extremely important to us.
And in general, our focus on operational excellence means that on average we run margins, which are approximately twice that of what you’ll find in a single point or a small group there very, very still large group, and is over 18,000 dealerships, or there is right around 18,000 dealerships in this country. So still an awful lot of dealers and most of them are small groups, one or two stores or single points, our margins are approximately double what they are.
We very much view the Company as a portfolio of assets, our stores are viewed in that approach. We focused very much on the return, although our overall strategy is to grow the Company, and we continue to grow the Company. We will sell car stores if somebody provides us a price for which makes sense to our owners our shareholders, so it’s very much about managing that portfolio of stores.
And finally, deploying capital, and we’ll talk a little bit more on subsequent slide here, but first and foremost, it’s making sure that we are appropriately investing our business, which goes back to the theme of operational excellence. After that we look at making sure we maintain a strong balance sheet, and we have one of the strongest balance sheets in the industry at the moment.
And then finally, if we run our company correctly and hopefully we do, if we are prudent in what we are doing in investing in the business, we are prudent about the acquisitions we make, we believe strongly that there will be cash in excess at that the Company generates, and that cash needs to be returned to our shareholders, and so we have a program of continually returning capital to our shareholders.
This is the three year capital allocation plan; it’s very open, it’s very transparent and since we introduced this right around a year ago, this is exactly what we’ve been executing against. Expect our CapEx, that’s what we reinvest in the stores, whether that be upgrading facilities, maintaining compliance with dealer or with manufacturer, image programs, runs as an average about $35 million to $45 million a year to do that, with our fiscal plan. By the end of this year, we will have touch I think, virtually every store maybe say one or two in our portfolio in a major way, and so we feel very good about the fiscal plan right now that our stores operate in.
We continue to move towards acquiring and owing more of our assets. I will talk in a later slide about why we do that while we are spending. We expect to spend over the next 2.5 years now between $40 million and $50 million, we have spend some of that already on acquiring leases. We will talk about it but the short-end, there is two reasons we do that; one is to have operational control of the asset, which is the most important thing, but the second most important thing is generally there is some financial leverage, we can refinance these leases ourselves with money which is much cheaper than as what’s assumed in the lease rate.
We are in the business of growing the company. A little history, we’re a very methodical company in our approach to what we do things. We really stood back a little bit from being overly active in the acquisition market for a while where we got all of our internal processes in place and again that operational excellence in place, so that we feel comfortable that when we acquire a store, we could integrate that store and bring it up very quickly to the level of performance we expect at all of our stores.
We felt very comfortable with that last year and we made this statement that we’re now actively looking for acquisitions, and again I want to talk a little bit more about that in a moment, but we’ve stated that we are looking for $500 million to $600 million in revenue that we want to acquire over the next three years. That’s a little, quite consciously big both in timeline and what that means in terms of stores.
Stores can range anywhere. A single point can range anywhere from a couple of million dollars of revenue all the way up to $100 million of revenue. So it’s difficult to say what shape that $400 million to $600 million will take. We’ve made a good down payment on it, I mean, to date of that we have acquired about $150 million of revenue in the form of five stores that we bought in the last little less than a year.
And then finally, I talked about the fact that if run well, this model should generate cash in excess of what you need within the business. We feel it’s our job to return that. We made a public statement that we’ll be repatriating between $25 million and $30 million of capital per year.
Pretty pictures, this is starting to talk about the various elements of the business and we started off with new vehicle opportunity and sometimes I think we should change the order of this.
So, let me talk about the new vehicle opportunity. Overtime we do think that there is every reason to believe that the number of new vehicles retailed in this country will continue to increase. You can see it. The age of the fleet that’s on the road is at an all-time high, and although the vehicles being put out there today are incredibly reliable, and much better products than they were a few years ago, still when you’re running a fleet that’s 11 years old, and has a 150,000 miles on it, which is what the average is right now on the road, you begin to question how much older it can get before they need to be replaced. We do see in our stores now a higher proportion of what we call, need buyers, people bringing in vehicles which are just right at the end of their useful life and they need to be replaced.
The financing environment is incredibly interacted at the moment. So the consumer, basically we laughingly say, if you have a job we can get you car financing, and that’s pretty much is the case. There is a lot of great product being rolled out. The cadence in product is much faster these days. One, the manufacturers are able to retool much more quickly than they could in the past. Factories are much more flexible, but more and more of what a consumer wants in a vehicle within the cabinet of the vehicle is within the package, the electronic package within the vehicle, and that’s moving more cadence of the electronics industry versus the car industry.
So in just a couple of years when you step into a vehicle you can see a vast difference in what that vehicle provides internally, whether it’s the interaction with your smart phone, whether it’s the interaction will be a smartphone, whether it’s the interaction will be Internet, that continues to be improved and those features continue to move faster these days, so a lot of what the consumer wants is based upon seeing that and there is an increasing number of people out there.
So I think you can expect that over the next few years we have stated and believe this, people are much better experts than we are at predicting the SAAR, but in our mind, we should be getting near the peak we were back in the pre-2008 days sometime by 2015, and then we’ll see where it goes from there given these sort of macros in the market.
Used cars though is probably for us, one of the most exciting opportunities we have, everybody comes to Asbury, they look at public retailer, you own car dealerships, it’s all about new cars. We constantly say, it’s not about new cars. It really is a story about used cars and parts and service. Used cars and it’s an enormous opportunity. This market is anywhere from two to three times the size of the new car market. It’s highly fragmented, you can see here that the franchise dealers are 40% of the retail of used cars, and that is a huge amount of addressable market share.
You can see that we have continually improved the number of vehicles that we sell, there are 57,000 last year, and we continue to move that number up. We have an internal goal of being what we call one to one, which is for every new car we sell we want to sell a used car. We are making great progress towards getting that, the numbers move from about 0.6 to 1 until now, somewhere between 0.7, 0.8 to 1.
So we continue to drive that market and this market is hugely important to a car store and to us. The reason is that we often talk about in the car store there are several businesses. You have new business, you have used business, you have your F&I, finance and insurance business and then you have your parts and service business.
Used cars, obviously we get a gross on the used car. That margin is slightly above, not a lot, but slightly above what we get on a new car. So you get a slightly higher gross margin. The gross on a used car is not that different from the gross on a new car. A new car is running about $2,000 gross profit for us per vehicle. A used car is running at about $1,800, $1,900 per vehicle. So it’s pretty comparable transaction.
The difference is that this gives you an F&I transaction to talk about here as well as this car generally has money. And when we take a used car in, we recondition that car. We will put roughly $1,000, new tires, make sure the brakes are done, whatever. That business, that reconditioning is booked in the inventory at the full margin of that business and when we sell that car, we recapture all of that.
So essentially it keeps our service stores still and about 20% of our fixed operations of parts and service business is related to our used car business. It’s a huge opportunity here and the one that goes beyond the confines of the manufacturer. We are going to address that 60% of the market. We don’t see there. We generally have an advantage over a standalone used car operation in the high proportion of the vehicles we retail, we take in on trade. They’re buying the vast majority of their vehicles at auction.
The one thing I’ll say is when you buy a car at auction, we can guarantee you paid the highest price for it. That’s not necessarily the case when you are taking a trade and you have much more flexibility to crack that deal. So, when you take those advantages there is every opportunity to continue to grow this business. This market has changed. People now go to the vehicle they don’t go to a lot. They used to come to a brand in a large lot.
Now you can go, any of you, and I’m sure you’ve done it, can go on the Internet in any number of size and put the used car you want. It will populate actually every car or like that in the area you want and people, the consumer now goes to the car. They don’t go to a place. They go to the car, because that’s the car they want. And for a company like Asbury, who runs a very sophisticated Internet marketing, digital marketing operation, it gives us a huge advantage in used cars.
Parts and service, this is 50 plus percent margin business for us. It’s hugely profitable. It’s again a business that is very fragmented where most of the market is being done by mom-and-pop by very small operations or small chains. We have a huge opportunity here to recapture that market share, which we lost in the – I don’t know, if you call the golden days of the franchise dealer or I think today might be the golden days of the franchise dealer, but certainly a few years ago you kept your service stall still with warranty work. The cars are too good these days, but warranty work has been steadily declining part of our business with some swings.
Last quarter, we saw an uptick because there just happened to be a number of large recalls, but that’s not the norm. Overall it’s a small and relatively declining part of the business.
So you really now need to reach out and get the consumer back. The consumer you let go when they run off warranty, and again it comes back to having a very sophisticated digital marketing outreach program to those consumers bringing them in. We’re consistently growing this business, growing this business in sort of mid single-digits, which doesn’t sound terribly exciting until you realize that this is growing at 50% gross margin business in a company where the operating margin of the company is about 4.7%. So when you grow that part of the business as much as we are, has a huge impact on the bottom line, another major opportunity for us is to continue to grow the company organically.
F&I, this is where we have a participation in financing the company. Most of all vehicles are financed. We originate the loan. So we do all the credit work, we put the credit files together, and then we shop it for the customer to various banks. We get them the best deal in the market and for that we get a participation, and you can that’s about 38% of our F&I business. The rest is assigned products and three big products there are extended warranties, vehicle maintenance contracts and GAP insurance, which is guaranteed asset protection. It just protects the value of your car, if you get into a wreck early on, you’re not under water, but if you’re selling your car, if you’d finance for seven years and you sell it in two you don’t want to be under water and GAP insurance protects you on that and that’s where the majority of the business comes.
So we’ve steadily improved this business. We’ve taken what we call the F&I PVR, which is per vehicle retailed. So the amount we get for every car we sell has steadily increased over the last several years, and we just chin $1,300 per vehicle. So go back, I said earlier the gross on a vehicle on new vehicle is about $2,000. You get another $1,300 per vehicle selling F&I products. So huge piece of the business, and this is at a 100% gross margin.
We are a pure agent. We don’t take any risk in the financing, we don’t make any risk in the product. We are pure agents or broker of these products, and sell other people’s products, manufacturers’ products as well as from third-parties. And so, again hugely important piece because of the high gross margin on this, and we continue to feel that there is an opportunity to improve this business. We are still not best-in-class, this is one where we are still chasing best-in-class and we continue to improve this business every quarter, every year that we are around.
We’ve talked about lease versus owned, our goal is to own 75% of our properties. It doesn’t really don’t finance, because we make turnaround mortgage the property once we own it, the mortgages are generally written with attractive partners, the manufacturing partners, but the reason we want to own the property is because we constantly invest in the property to improve, we don’t want to be investing in somebody else’s land and somebody else’s building.
So we have steadily moved up the percentage of our ownership. This is 60% owned. I think right now we are about two-thirds owned in fact, we closed in a couple of more leases with the goal of being 75%. We actually would be 100% if we could, but 75% start reaching leases, we just need to wait to run their course. Two reasons for doing it; one is just the financial arbitrage and other is that operational flexibility it gives us.
Acquisitions; let me spend a little bit of time here. So we have talked about the Company having a substantial number of organic growth opportunities, particularly in the used and in the parts and service business. We also have a lot of opportunity in terms of just M&A and it’s not M&A and class, it’s not going on and buying huge companies where there is a lot of risks and lot of integration risks. This is about buying either single points or small groups of stores and bringing them into our portfolio.
There is somewhere between 17,000 and 18,000 dealers out there. I don’t remember the number exactly, but I think less than 10% of the market is covered by the public retailers. The vast majority of the market is still small group standalone dealership. They’re finding it increasingly difficult to compete in this world. They are doing okay now, because the market is so good. But they do not have the wherewithal to run in the sophisticated sort of digital marketing outreach we have to do to be in a successful retailer in this business these days.
Statistically often quote is that four, five years ago the average consumer visited just slightly north of four stores before they made a purchase. Today that consumer essentially visits one store. They do all their shopping online, they decide where they are going to go and then they go and they make their purchase. How do you get that consumer into your store, because they’re no longer visiting several? A lot of retailers will never even see that consumer. How do you make sure they come to your store, and it’s done now through having very sophisticated tools and customer relationship management, digital marketing, digital outreach to the consumer extremely well built and attractive websites that they can visit.
There is a whole bunch of things. We have a group of people in the company that do nothing, but online reputation management. That is the last thing you want when somebody is deciding where they are going to buy their next BMW and they call up your dealer, Nalley BMW in our case and the first thing they see is some – I was treated very badly there. Which car store you are going to visit? It’s not going to be that one. So we have a group that does nothing, but online reputation management. That’s not something that these small groups can do and they don’t. We run margins which are approximately twice that these small groups do.
So there is a lot of compelling reasons why there is going to be continued consolidation in this business, and we will participate in that.
Like we have stated, our goal is $400 million to $600 million of revenue. We’ve acquired $150 million. We are very disciplined in doing this. Unlike a lot of acquisitions, when you buy car stores, it’s not about cost synergies. There aren’t huge amounts of costs you take out, is a very simple operation, it’s been all run the same. It’s really about bringing your people, your training, your processes, your systems into that car store and training people to do it better. So we can typically move a car store from where it was performing when we purchased it to be in doing substantially better.
About not even a year ago, we bought a VW store in the Atlanta market. When we bought that store, that Volkswagen store was the worst performing store in the entire region for Volkswagen. By March, three months after we acquired that store, they were the second best performing store in the entire Volkswagen district, and are closing very rapidly on number one. There is no magic, we brought in our systems, our processes, couple of our people, the General Manager, and a couple of others, not a lot, it is mainly training the people who were there, and have substantially changed the profit profile of that store.
That’s what we look for when we acquire stores. It’s that ability to significantly improve it, because we may pay an amount which based on our current performance, we do it sometimes scratch our head, but that’s what the market is, but if we can substantially improve their performance, we can make this make sense for our shareholders, and we always look at, we are not trying to just drive the EPS, we really look at this as generate shareholder value, we look at cash flow, hard and fast cash flow on these deals and does it make sense in terms of return on cash flow.
So there is a huge opportunity here. We are very disciplined about it. Frankly, if we do have a downturn we don’t see one coming, but inevitably I suspect we all know that these things happen. There’s probably going to be a lot much larger opportunity maybe pick up some of these still larger groups that are out there that are still privately held.
Capital deployment, I want to get to the questions here. So I’m not going to say a lot of that. I think I’ve already talked about this. Valuation, we have really closed the valuation gap with our peer group. I think people are finally caught on to the back used to trail the peer group badly.
I think people have now learned that we are very good operator and we pretty much close that valuation gap with our peer group, but we still as the Group trial the specialty retailers, and I think that’s largely because people think it was the new car story, new car growth is limited when, if I leave any message behind, it’s not a new car story. It’s a used car story, and it’s the parts and service story in terms of driving profitability. We’ve talked about all the pieces of the business here that work together, so I won’t belabor that.
Why Asbury, and I’ve already talked about a lot of this. It’s a strong stable team. It’s a great balance sheet. We have tremendous financial flexibility. We’ve run a very disciplined company. What we say is what you get. We’re simple business model to evaluate. If you want to invest in a finance company invest in a finance company. We don’t do that. We sell cars and we’re going to stick there, and I think there is every reason to believe that we’ll continue to outperform our industry given our operational excellence.
And I think that leaves a couple of minutes, try to hurry along here for questions.
Great. Thank you. Thanks for the presentation (inaudible) and first, what do you look to pay for stores, and how that compares to the multiples at which you stock trades in the marketplace?
Scott J. Krenz
Well, then that’s exactly what we’re looking at. We’re real simple people. Maybe I was laughing before. Car people are not terribly sophisticated people and we are real simple people. So we just asked what cash do we get back, cash and cash, how much cash we are going to pay all in on a deal and what we are going to get back and what’s the multiple.
The company trades roughly somewhere between eight and nine times our EBITDA right now. So when we get done with a deal we do not want to pay more that what we trade at for that deal. You need to either be there or less. The market dictates what you pay and this is why operational excellence is still important.
Today car stores are doing really well. People make a lot of money without having to do a heck lot of work sometimes in these stores. You can see prices being commanded for luxury stores. They can be anywhere from 10 to 12 times your cash flow. You can see import stores roughly in the 10 range and some domestics in the nines or something like that. If that was the end of it, we wouldn’t be buying any stores. But like the Volkswagen store I referenced, we can go in and very quickly see this is going to improve and that one, that store gets up our performance parameters will be effectively trading below that eight to nine we trade at. That’s what we look for in an acquisition.
Okay, great. And lastly from me, just in the presentation you referenced what some of us, analysts are looking for in terms of light vehicle sales in 2013 and you mentioned some of the supporting factors for sales going forward, average vehicle age, et cetera. I’m just curious you being in the vehicle retail industry, what personal or company view you have in terms of what long-term U.S. demand is for light vehicles?
Scott J. Krenz
There are some changes dramatically and if there is nothing, I think on the – even the mid-term horizon, that’s going to change it dramatically. We are going to be selling more vehicles. Now we may see some cycles in there, some dips, but overall the trend is going to be upwards. It has to be. There is just more drivers on the road.
I was going to dovetail over here. We’ve seen yen depreciate right in front of the A and B segment getting competitive. What are you seeing out of the J3, any changes on the incentive front and specifically looking at cash dealer and incentive buying up residuals? Have you seeing anything changed from that group?
Scott J. Krenz
No. I think that the incentive environment right now is still pretty benign there, but people really are not – we haven’t seen any real push. Occasional we’ll see some pushes on particular models, like when the Honda was trying to clear out the 2012 accords to the 2013 company they were pretty aggressive with this 2012, but it will be model specific.
In general, it’s a pretty benign environment, lot of speculation about the J3 and what they’d be pushing there. They clearly want to recapture market. So the J3 are, whether it’s Honda, Nissan or Toyota, they are pretty aggressive. They are pretty proud companies and they want to do better. Right now we are seeing some fairly, you see the numbers as well as I did, some fairly strong growth rates from all of them without having do anything untoward. So, right now it’s pretty benign. They don’t share with us. You’d think we know more. You guys sometimes know more than we do about what they are thinking because they talk to them more, because they don’t – they play that pretty close to their vest.
And then real quick, have you guys seen any sign that generation wise starting to come in to the auto line market, leaving their iPads to buy a car?
Scott J. Krenz
Well, you’ve said it. Yes, we are because we’re seeing more consumers who are doing all their research and stuff with their iPads. I mean the consumer today is very much changing and it’s a consumer which is much more comfortable doing the bulk of the work on line and that’s a different generation, which is starting to come into the stores is the person who is sitting there, doing all the research and finally we’d love that, we welcome those people in. If they haven’t done it, we will sometimes do the research for them right there, because for us, our profit is not from selling the vehicle, it’s because of the relationship in servicing that vehicle, and so we want to maintain that relationship, so we try and be very straight-forward, but yes, the consumer, it’s got to be the newer generation just so much more comfortable dealing with the world whether it’s through Facebook and social media and all of that.
We are seeing much more of that in the business, which is why we changed so much, and become a digitally oriented business. We don’t do a lot of printer advertising on the radio or stuff anymore, those are cheesy ads, we don’t do much of that at all. The vast majority of our marketing now is digital online marketing.
What are your economics, leasing versus selling cars, and how are you positioning yourself for the electric vehicle in the future?
Scott J. Krenz
Lease business is a great business. The majority of leases are originated by the manufacturers, the strong residual value of the used cars, when it comes back is supporting very low lease rates for the consumer. So we get very good deals for the consumer on leases. We as a retailer love it, because there is a high probability that in three years, we will get that leased vehicle back most of the lease buyers are they are on lease, because they want to change their vehicle every three years, and that is gold to us, because that is a vehicle we can then take back and trade and we can recondition ourselves as certify preowned which is a great piece of the business.
So leasing business is very strong. We spoke the low cost the money environment we are in combined with the high residual value of the cars is providing great deals.
Future of the electric car, I’ll quote one of the icons of our industry, Sid DeBoer, if you don’t know Sid DeBoer, is the Founder of and the CEO of Lithia, one of our esteemed competitors, and when asked that same question, Sid said, ‘why don’t you people just all admit, they’re nothing but big golf carts.
We don’t see in our markets to be serious, we don’t sell a lot of electric vehicles in our markets. I think they do very well in certain niche markets, but in our markets they’re just there, they just don’t sell that well, and we can talk about whether or not bad we still ever have enough range and stuff to be in other than certain urban markets, not to be in those, no.
Okay. Please join me in thanking, Scott and Ryan for coming this year.
Ryan T. Marsh
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