Group 1 (NYSE:GPI) reported earnings yesterday and then saw shares slump 10% before recovering back some lost ground later in the day.
Snapshot of the Results
4Q06 Total same-store sales: down 3.1%
New: down 2.9% (retail)
Used: down 4.1% (retail), down 11.5% (wholesale), down 5.9% (total)
Parts and service: up 0.6%
F&I: up 1.2%
4Q06 Gross profit: 15.6% down 20 basis points from 15.8% in the prior year period
New: 6.8%, down 30 basis points from the prior year period.
Used: 12.5%, down 10 basis points from 12.6% last year.
Parts and service: 54%, down 20 basis points from 54.3% in the prior year period.
SG&A as a percent of gross: 80.3%, down from 80.2% in last year's fourth quarter. But on a same-store sales basis was up 60 basis points as "decline in gross profit outpaced expense reduction in the quarter.
Tax rate: 34.4% up from 30.2% last year.
Share count: 24.063 million versus 24.465 million last year.
Long-term debt/cap: 38%
To grow the top line and gross
- Earl Hesterberg, CEO of Group 1 Automotive on #1 priority for 2007
Group 1 4Q06 earnings
Group 1 reported earnings (excluding charges) of $16.3 million, or $0.67 per share in the fourth quarter of 2006. The headlines are all screaming about Group 1 missing numbers by $0.11 (versus Reuters consensus), suggesting most analysts were looking for around $0.78. When I checked Zack's survey of analysts, they were even looking for something higher ($0.80!).
I was looking for $0.63, so forgive me if my take on Group 1's earnings are a little different than the rest of the street. But I want to apologize to investors. Once again, I am supposed to be a resource of insight/understanding about the sector. So if investors (including the sell side) are confused, it is because I failed to issue an earnings preview and brace investors for this apparent misunderstanding (about how the quarters should be spread).
Now having said that, I still don't think people should get worked up about a quarter. Adjusting for some charges in both periods, the $0.67 is slightly better than the $0.66 reported in 4Q05, which considering how difficult the comparisons were, I find pretty darn impressive.
Tough earnings comp, coming back to earth
But let me explain the disconnect that I think is happening between investor perceptions of Group 1's 4Q06 earnings results, and the reality of their results. Remember, in the third quarter of 2005 hurricane Katrina came in and devastated the Gulf State region. Group 1, out of all of the dealer groups had the greatest exposure to this region with over 50% of the company's revenues coming from Central and Southeast (which if you look at the map, a good chunk of the company's stores in those regions hug the gulf coast).
This left for an "easy" comparison in the third quarter of 2006 (which combined with internal initiatives) likely helped the company post the 25% year over year earnings improvement in the third quarter of 2006. But it also set the company up for "tough" earnings comparisons this quarter versus the fourth quarter of 2005 as a lot of vehicles were replaced/repaired during the post Katrina rebuild period.
I think the best example is the company's F-Series trucks. You heard a lot on the conference call and even in the release about Group 1's 36% decline in F-Series truck sales in the fourth quarter. Pete Delongchamps, manufacturer relations, said on the call that roughly 47% of the company's Ford volumes were the F-series (a disproportionately high figure). I still remember George Pipas (Ford's head of sales analysis) explaining in the fourth quarter of 2005 that they were seeing huge demand for their F-Series trucks in the gulf coast region (pick up trucks are popular with construction work).
Now Group 1's management appropriately pointed out on the conference call that they didn't complain when they got the benefit from the post Katrina rebuild effort, so they shouldn't complain when they experience the headwind. I appreciate that comment. But, when you consider the difficult earnings comparison (going up against ~40% year over year earnings growth in 4Q05), I think being even slightly up is pretty encouraging.
In any case, if you really look at the annual earnings (excluding out a $0.06 asset impairment charge), Group 1 had net earnings per share of $3.68, a 25% increase from 2005, and almost right in the middle of management's guidance given at the end of the third quarter ($3.65 to $3.75).
Now every management team likes to come in at the high end or even beat it. So I can understand that the last week of December (which is what 4Q really hinges on) likely came in a little weaker than management anticipated, and why you heard comments about advertising expenses and inventories being higher than where they would like.
But what I really think is causing the 7% (decline) reaction in the stock today is investors are simply being "returned back to earth."
Remember, we (as investors) are trying to assess future returns. Management reiterated guidance for earnings in 2007 to be in a range of $4.00 to $4.25, and nothing from the 4Q06 results or articulated strategy on the conference call has changed. However, I think (we) observers have become overly accustomed to the company exceeding expectations. It was 12-months ago that I raised the issue on the company's conference call (and in my notes) that management guidance did not seem "conservative." If anything, it seemed rather aggressive. And what happened? They continued to raise up their full year expectations as management delivered greater store productivity than I think any of us ever could have imagined.
Now I think (as was even raised by myself and others at the time) the company seemed to catch the "perfect storm" associated with internal initiatives occurring simultaneous with the favorable tail winds what came from the post Katrina rebuild efforts in the gulf coast region. But the bottom line is that planning on the company blowing away even the high end of their guidance (as the street and admittedly I have even done in 2007 forecasting) has probably come to pass.
Note, the 2007 analyst consensus on Zack's calls for 2007 earnings of $4.33, and I was even worse forecasting $4.35 in 2007. You will likely see me and the other analysts return to earth as the new estimates are published. I should also point out that the first quarter comparisons may prove even more difficult than the fourth quarter.
Group 1 is going up against 50% year over year earnings growth in 1Q06, even more difficult than the 40% earnings comparisons that they went against in the fourth quarter.
My last published estimate was $1.10 in 1Q07, and the consensus forecast of $1.02 will therefore probably need to be revisited. In fact, earnings may very well prove flat to down in 1Q07.
Toward Greater Productivity
While the expectations on the street are coming back to earth, what I think is more important to notice the subtle shift occurring at Group 1. You've heard the expression "you can't cost cut your way to prosperity." During 2006 you clearly saw the new management team come in and right size the cost structure of the organization. And while I think the company still has a lot of "low hanging fruit" as I have discussed in other notes (following meetings with management), I think you clearly see management becoming more focused on this idea of productivity (versus just cost reductions).
On the conference call, I asked CEO Earl Hesterberg what Group 1's top priority was in 2007? He said: "to grow the top line and gross." I would encourage him to focus more on the gross line (as I have discussed in the past at dealerships that is really your revenues and what all expenses need to be based on). But, Mr. Hesterberg went on to say that they can take out all of the costs in the world, but what they really need to do is start moving the top line (once again I would focus on the gross) in the right direction.
And this stems from utilizing your talent the most efficiently. I think John Rickel (Group 1's CFO) said it best to me an email (that I published on 02/08/07) where he said:
What we are trying to do is let our operators focus on those areas where their skills and talents add the most value (customer interface, merchandise selection, selecting the best advertising and deciding which advertising medium to use, personnel selection, compensation, team management and motivation, etc, etc). versus having them spend time trying to negotiate discounts with light bulb suppliers or worry about managing an accounting department.
Often times in business we tend to view cost cutting as a trade off with higher sales and customer service. And yet it really seems (as Mr. Rickel articulates) that these two dynamics (of higher sales and lower costs) can be symbiotic (mutually beneficial relationship), if the focus is on maximizing the talents of each of your employees (which in the dealer world are your assets).
I think management's ability to improve the effectiveness and productivity of its employees (as they are trying to do) will be far more influential in Group 1 being able to meet, exceed, or miss their targeted earnings of $4.00 to $4.25 in 2007 than how the California housing market fairs. Just my opinion.
GPI 1-yr chart: