Penske Automotive's (PAG) CEO Roger Penske on Q2 2016 Results - Earnings Call Transcript

| About: Penske Automotive (PAG)

Penske Automotive Group, Inc. (NYSE:PAG)

Q2 2016 Earnings Conference Call

July 28, 2016 14:00 A.M. ET

Executives

Anthony R. Pordon - EVP, IR and Corporate Development

Roger S. Penske - Chairman and CEO

J.D. Carlson - EVP and CFO

Shelley Hulgrave - Controller

Analysts

John Murphy - Bank of America-Merrill Lynch

Richard Nelson - Stephens, Inc.

Brian Sponheimer - Gabelli & Co.

Paresh Jain - Morgan Stanley

William Armstrong - C.L. King & Associates

David Lim - Wells Fargo

Brett Hoselton - KeyBanc

Michael Montani - Evercore ISI

Unidentified Analyst - Goldman Sachs

David Whiston - Morningstar

Carl Dorf - Dorf Asset Management

Douglas Karson - Bank of America-Merrill Lynch

Operator

Good afternoon, ladies and gentlemen. Welcome to the Penske Automotive Group Second Quarter 2016 Earnings Conference Call. Today’s call is being recorded and will be available for replay approximately one hour after completion through August 4, 2016. It is on the company’s website under the Investor Relations tab at www.penskeautomotive.com.

I will now introduce Tony Pordon, the company’s Executive Vice President of Investor Relations and Corporate Development. Please go ahead.

Anthony R. Pordon

Thank you, John and good afternoon everyone. A press release detailing Penske Automotive Group’s second quarter 2016 financial results was issued this morning and is posted on our website, along with a presentation designed to assist you in understanding our performance. Joining me for today’s call is Roger Penske, our Chairman; J.D. Carlson, our Chief Financial Officer; and Shelley Hulgrave, our Controller.

On this call, we will be discussing certain non-GAAP financial measures, such as earnings before interest, taxes, depreciation and amortization or EBITDA. We have reconciled these measures in this morning’s press release and investor presentation, which is available on our website to the most directly comparable GAAP measures. Also, we may make forward-looking statements about our operations. 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 on factors that could cause results to differ materially.

I will now turn the call over to Roger Penske.

Roger S. Penske

Thank you, Tony. Good afternoon, everyone and thank you for joining us today. I am pleased to report another strong quarter for Penske Automotive Group including the best quarter and the highest retail unit sales, revenue, income from continuing operations, and earnings per share in company history.

In the second quarter, income from continuing operations increased 0.6% to $94.7 million, and related earnings per share increased 6.7% to $1.11. To exclude foreign exchange, our income from continuing operations would have increased 3.5% to $97.4 million and EPS would have increased 9.6% to $1.14. During the second quarter, our premier truck subsidiary acquired Harper Truck Centers located in Ontario, Canada with five dealership locations in the Greater Toronto. The acquisition is expected to generate approximately $130 million of annualized revenue.

During the quarter we further solidified our capital structure by issuing 500 million in senior subordinated notes at 5.5%. We used the net proceeds from this offering to repay amounts outstanding under the company's U.S. credit agreement and floor plan debt. Reflecting the continued strength of our business, yesterday our Board of Directors increased our dividend to $0.28 per share offering the PAG shareholders a current yield of approximately 3.2%, the highest in automotive retail space.

I am also very pleased to announce today that we have acquired an additional 14.4% interest in Penske Truck Leasing for approximately $498 million and now own 23.4% of PTL. This is a significant acquisition for our company. By acquiring the additional interest in PTL, the company expects to realize accretion to earnings per share along with the strong cash flow from projected cash tax savings and the annual cash distributions PTL provides to its partners. We estimate the transaction will provide at least $0.25 per share earnings accretion on an annualized basis and also provide significant cash tax savings which we believe will be heavily weighted to the first few years of the investment. During those first few years we estimate the cash on cash return to be between 30% and 35% for the consideration paid.

Now let's turn to the details of our second quarter performance. Revenue increased 6.8% to $5.3 billion and same-store retail revenue increased 0.2%. If we exclude foreign exchange, revenue increased 9.2% including 2.7% on a same-store basis. Approximately 92% of our total revenue was generated through our retail automotive dealerships. If you look at the mix, our international business now climbed to 40% of our business and North America was 60%.

Overall gross profit improved $40 million to 5.5% and gross margin was 14.7%. SG&A to gross profit was 75.5% down 10 basis points, gross profit flow through was 26% including 32% in our auto retail business. Operating income increased 3.3% to 164 million and operating margin was 3.1%. During the quarter 86% of our income was derived from automotive retail, 5% from North American commercial truck dealerships, and 9% from other which includes Australia and our non-automotive joint venture investment, Australia due to automotive retail business. Retail automotive revenue increased 6.2% to $4.8 billion including 0.7% on a same store basis.

Exchange rates negatively impacted the same store retail automotive revenue by 107 million excluding foreign exchange same store retail revenue would have increased 2.7%. Our brand mix if you look at it for the quarter 72% was premium luxury, 24% was volume foreign, and 4% was the Big Three. On a same store basis the variable gross profit per unit, that is gross profit from new vehicles, used vehicles, and F&I was $3613 up $43 per unit.

Turning to new vehicles, new vehicles retail increased 5.7% to just over 62,000. Same store new units declined 1.4. On the other hand gross profit for new unit retail increased $100 to $3106 and gross margin improved 30 basis points to 7.8%. Gross profit increased $118 per unit sequentially. Excluding foreign exchange gross profit per unit retailed was 31.75 and an increase of $169 per unit. If you look at our daily supply at the end of June on a worldwide basis it was 66 days.

Turning to our used vehicle business, we retailed almost 53,000 units in the second quarter, up 6.8% and same store unit declined 2.6. CPO sales represented approximately 40% of our sales during the second quarter in the U.S. Our used to new ratio was 0.85 to 1. Our used vehicle revenue increased 6.9% or $1.5 billion. Gross profit per unit -- used unit retail was $1697 down $85 per unit. However, on a sequential basis gross profit per units retail increased $99. Margin was 6.1% down 30 basis points but up 10 basis points sequentially.

Excluding foreign exchange gross profit per unit was 1736 down $47 per unit. Our supply of used vehicles was 43 days at the end of June. Financial insurance revenue per unit was $1092 down $32 per unit excluding foreign exchange. F&I revenue per unit was $1118 down $6. On a same store basis excluding foreign exchange F&I revenue increased $69 to $1194. Service and parts revenue increased 8.8% including a 3.4% on a same store basis. Excluding foreign exchange, same store service and parts revenue increased 5.2%. Excluding exchange our customer pay was up over 7%, warranty was up 0.5%, body shop was up over 4%, and our PDI was down just under 3%.

Turning to the retail commercial truck business, in the second quarter our dealerships generated $309 million in revenue and $38 million in gross profit. Total new and used retail sales increased 24% and just over 2200 units including 8.4% on a same store basis. Same store new truck sales increased 12.2% and same store used trucks declined 10%. Service and parts represented 26% of our revenue in the heavy truck business but also represented 77% of our gross profit in the second quarter. Our margin was flat to 37% but our fixed cost absorption ratio was 117% in the quarter.

Looking at our balance sheet, we had $98 million of cash on our balance sheet at the end of June and our non-vehicle debt was $1.7 billion. As previously mentioned, we issued 500 million in senior subordinated notes with 5.5% in May of 2016. We used the proceeds to repay amounts outstanding on our U.S. revolver and floor plan debt. As of June 30th, we had over 700 million in liquidity and our leverage ratio was 2.5 times. After closing the PTL transaction in July, the company's lever ratio is still low at 3.1 and our debt to capitalization was approximately 55%.

Our new and used automotive inventory was $2.8 billion at the end of June, down 135 million from the end of December. And on a same-store basis, new and used vehicle inventory was down $175 million from the end of December; new inventory down $183 million, used up $8 million. Approximately $57 million of our U.S. inventory is currently on OEMs stop sale, representing approximately 2,600 vehicles. New vehicles value of $22 million approximately 400 units, used vehicles at 35 million in value, approximately 2,200 units. Only minimal amounts of inventory are on stop sale in the international markets. Capital expenditures were approximately $137 million year-to-date which includes 32 million for land purchases and our lease buy out which we replaced with a mortgage.

Before opening the call for questions I wanted to address the referendum of Brexit vote filed in the UK. Obviously I have had a lot of questions regarding the effect of this vote on our business. Well, this is an unprecedented event. We remain positive and encouraged about our business in the UK and throughout Europe. With very strong and experienced management team on the ground in the UK, we are encouraged by the formation of the new government, which occurred quicker than most anticipated. Remember we buy and sell in British pounds. Our revenues and expenses are dominated in British pounds so we have a natural hedge. Our exposure essentially is limited to translation of UK results into U.S. dollars. There is no transaction risk.

UK light vehicle sales are over 50% company cars. User vehicle were typically at three year personal contract purchase which is very similar to lease and provides replacement demand as the lease expires. Remaining 50% of the new vehicle market are predominantly retail sales to private individuals. Also the UK is net importer and a very important market within Europe. We believe the remaining EU countries will look to negotiate favorable trade deals for the UK to protect the market for their products.

If you look at the first 25 days of July, compare that to the same period last year for our business in the UK, the new vehicle orders are up 3%, our used vehicle orders are up 5%. Based on our full year results in 2015 if we just translate it, the UK results into U.S. dollars in 2015 at the current rate of roughly $1.32 it would impact us approximately 900 million in revenue and the effect on our EPS would have been $0.20, that gives you an idea of the impact of the pound going from roughly $1.50 to $1.30.

In closing I think we are very pleased with the performance of our business this year and continue to believe in the strength of our diversified transportation service model and its ability to adapt to the market conditions and generate significant cash flow for the future. We are very positive about the PTL acquisition and the accretion and the tax benefits which we will be able to unlock through this additional investment. The accretion and cash flow from this investment should more than offset the EPS effect from translation adjustment we might expect from Brexit. Thanks for joining us, let's open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. And first we will go to John Murphy with Bank of America-Merrill Lynch. Please go ahead.

John Murphy

Good afternoon Roger.

Roger S. Penske

Hi, John.

John Murphy

Just a first question and follow-up on Brexit. I mean, obviously you sound like some of the early signs post vote referendum are reasonably constructed relative to some of the fears in the market, I was just wondering if UK highlighted any period in time you could remember where you had disruptions. Obviously this has been unprecedented, but any other disruptions on different markets where your retail customer given your brand mix focused on highlighting lux brands in the UK may have held in a lot better than the general consumer. I am just trying to understand even if the market weakened little bit over there where your customers will show up more?

Roger S. Penske

I really, I can't just, I will hand -- give you that info. I would say though remember the good news is that the premium luxury business is about 700,000 units and we have 9% of that market and that has been growing up from roughly 17% to 25%. So the year it is in operation have grown substantially so that five year units in operation will drive a lot of parts and service for us. So, I think as I look at it we have got the fixed side of the business stronger and usually the premium luxury -- you even saw it through some of the financial crisis seems to hold on a little bit better. There may be the volume franchises and also there is a lot of lease business in the UK so we would see that probably holding on as it has in the past. Previously we would fund those cars until leases were up.

And remember one thing, with the new to used -- our new to used penetration in the UK is over 1 to 1, so we still have our strong used car business we would expect. Because people might not want to buy new but we would then have the used car opportunity and we have seen that grow. I think you saw it during the financial crisis here in the U.S. So, maybe that would be an offset for that.

John Murphy

Okay, that is helpful. And then a second question, it seems like some of the inventory pressures we saw at the end of last year and the beginning of this year, they were putting pressure on gross profit per unit. On the new side it seems it did ease, I mean, are you seeing a more rational relationship or are you seeing a more rational behavior from your automakers as far as delivering inventory and your ability to sort of talk to them and say hey, we have got enough inventory right now, we need to work through what we got, and they are acting little bit more rationally and there is more rational environment among your competition particularly on the luxury side?

Roger S. Penske

We have said no at certain points on certain models and I think we have done a real good job in managing our inventory because when you look at the overall, in the U.S. we got 71 days, internationally we got 57 days with a total 66. And yet on a same store basis our inventory is down almost 190 million. And I think that most of the mix shift there obviously as we have seen going from cars to trucks and SUVs. There is no question that we have had maybe overloaded on some of the series in the premium luxury that maybe are not in the truck side. So, we have got to manage that.

But I think overall I have seen some of the manufacturers slowing down some of the inventory. I know that BMW said that they are going to look real carefully on what they supply here to the end of the year. But I think they are being rational. I think initially because China slowed down and had more inventory I thought they would really dump it here in the U.S. But I think their premium luxury side, Porsches, we could use more Porsches certainly. Audi has been good for us and as we look overall I think the BMW will be in the second half. The mix shift there will be probably over 50%, there will be trucks or SUVs. So, we have to learn how to manage through that and I think that the 71 days when you look at overall we don’t have the impact of the domestics that some of the other people that are over 90 or 100 days. So, it is really not a problem I am focusing on.

John Murphy

Okay, and then can you just talk about little bit about the tax benefits from the PTL acquisition and really I think you kind of talked about it being in the first couple of years, I am just curious how long those benefits could last and if you could just maybe dimension them as best, I mean I know it is tough to calc but I mean they mention them as best as you can for us as far as sort of size and duration of those benefits?

Roger S. Penske

Well number one, we have to get profits in the U.S. in order to be able to take advantages of the tax benefits. And typically under the revenue code you can go back two years and you can go forward to twenty. So whatever benefits we get from the accelerated depreciation and bonus depreciation that you have, our truck leasing investment that will stay with us through a long period. I think I said on the call that we are looking as we got to 30% or 35% cash on cash benefit on 500 million you can do math yourself. We see that in the short-term probably over the next 12 to 18 months max. So, it is very strong for us.

John Murphy

That is incredibly helpful. And then just lastly, it sounds like if you looked at the stop sale vehicles about 2600 I think you mentioned, that represented about 2.2% of your sales in the quarter and around 2% in any given quarter. Do you think there will be a period where some of the parts actually come in sort of big quantities, you get these cars fixed so you have a big -- you have maybe a material step up in warranty work and then you also get this bump from the used vehicle sales finally get out there in the market. Is that something that could happen in the third quarter or fourth quarter if you get all these air bags in?

Roger S. Penske

Well number one, it is not a big number of hours. I think as we do these it is not too complex and what we have to do is we got to focus on customer cars and then we would focus on cars and inventory. And I see these starting to roll between Honda and certainly BMW are the prime targets. The good news is that some of the vehicles we have on stop sale are very good used cars and I think that has had some forward impact on our used car business and at least in BMW here. They all remained over the last 60 days but I see that going out. The only risk that I think we have is if everybody decide to host their leased cars into the market instead of retail there might be some residual probably a value deterioration going forward. But we are certainly looking at 0.85 to 1 used to new. And when you look at today, if I looked at BMW I am over 1 to 1 used to new. So, we see that as an opportunity not as a risk.

John Murphy

Great, thank you very much.

Roger S. Penske

Thanks John.

Operator

Next we go to Rick Nelson with Stephens. Please go ahead.

Richard Nelson

Hi, thanks, good afternoon.

Roger S. Penske

Hi, Rick.

Richard Nelson

Roger a question actually about the dividend. We have seen a penny increase I think going back 21 quarters, a penny each quarter, you have got a 3% dividend yield today. Is that -- what sort of payout ratio are you targeting?

Roger S. Penske

No, right now our payouts are about 25% and I think I shared in previous discussions that we would try to get to 30% to 35%. And I think that the shareholders that I talked to certainly the ones I represent, like dividend. So I think that is realistic.

Richard Nelson

Thanks, thanks for that. Also with PTL now in your basket do you go a little slower on the acquisition front and maybe take another bite out of the remaining GE stake down the road?

Roger S. Penske

What I can tell you is that certainly on our Board they take a look at it but we got to be sure that our balance sheet is safe and secure and we are going to be an opportunistic buyer there, there is no question about it. We can generate the cash flow we expect from earnings and then with the tax savings we will be taking a good look at that as we go forward. And there is no commitment by us to do that. But on the other hand it is certainly something we want to do because it is now 15% less than we feel that it will be a great additional asset to own by PAG.

Richard Nelson

Well, nobody knows it better than you guys. Thanks very much.

Roger S. Penske

Okay, thanks.

Operator

Our next question is from James Albertine from Consumer Edge Research. Please go ahead.

James Albertine

Hey J.D. J.D. and Roger good afternoon and to Tony as well.

J.D. Carlson

Hey James.

James Albertine

I wanted to ask if I may on I think you called it before Roger young used vehicles or late model used vehicles, I wanted to get a sense or an update as to the trends underlying the second quarter and maybe some views on the back half?

Roger S. Penske

Well I think that we are -- the ability to provide in the premium luxury side the service customer who own a car, we have really ramped up our own a car fleet to several thousand. And management is determined that these are very good cars, we get them out with lot of mileage. So, what we have tried to do is accelerate that and trying to have cars that are anywhere from 3000 to 4000 miles max and pull those out. And these are not cars we can't sell. We just put them under and these are good cars that are -- we know they will come out and have good value because we depreciate them roughly say 1.5% to 2.5% per month and we put them in that. We bring those cars out and then we are able to apply the new car programs to those with a different manufacturers and they become a very good car to move a customer that maybe doesn’t want to reach for a new car and will buy one of these young used cars that will lower payment if it is lease or even a transaction now where he might finance it. And we have seen that quite rapid in growth from the standpoint of unit sales in the last say quarter and we expect debt to be our offense to the end of the year.

So, with the OEMs wanting us to take more of these vehicles that gives us the opportunity to be able to put them into loader and I think that these lease returns also that we will get, to give an example, with BMW 10000 coming back just in 2016. So, this is a field that owns the engine for us on the used car side and that is what I said earlier, just a BMW over one to one are used to new. So, I think these programs and these young users they are almost like another channel for us.

James Albertine

Would you say as a follow-up to that, that you are essentially driving an incremental customer into your dealerships as used supply improves?

Roger S. Penske

Well, I think at some point I might be cannibalizing a little bit on my new customer at certain times of the month or the year but it is an opportunistic buy for the customer. But the good news is I take a customer, I put him into an almost new vehicle, I am going to get that parts and service and if it is a lease I am going to get that opportunity to get that car back in 24 or 36 months. So, I think it is fair, really important to do that and obviously with the internet we can put these cars out in the internet and also with penskecars.com we are getting a lot of traffic there which really, really will help us. And our digital marketing has really moved up, mobile growth in fact if I went back and looked at it, it is up almost 25% in the second quarter. And we are finding as you look at it, I looked at the numbers just in the last couple of days, almost half of our traffic comes from mobile. So, this is, we have this kind of inventory. There is lots of availability and eyeballs on this type of inventory.

James Albertine

Thank you. I actually appreciate the color there and also the color on digital. And then maybe by way of a housekeeping item, as we think about the incremental $0.25 related to PTL can you help us understand again or just remind us the seasonality. So, as we think about 3Q and 4Q of this year, so how to think about that flowing through?

Roger S. Penske

The strongest quarters here are probably in the second and third quarter number one, because we have the one way business. That is rent it here, leave it there and this is when the kids get out of school and they go back, so we did about 600,000 one way rentals and a big portion of that was done. In the middle of the year we get a little bit of a spike in rental. And at the end of the year when FedEx and UPS take 4000 or 5000 vehicles from us but I would say it is more weighted the middle two quarters versus Q1. Really there is not much one way business at that point. And then of course people seem to be moving their jobs at the end of the summer so we get that movement again on the one way side. So, that were things that I would look at. But again as we grow our logistics business which is we have got a $5 billion business there and 25% of its logistics and we continue to grow them and that's really grows on the basis of the major automotive accounts and other types of industries and we see that starting to flatten out in our earnings across the 12 months.

James Albertine

Got it, well thank you again and best of luck in your next quarter.

Roger S. Penske

Thanks.

Operator

Next we will go to Brian Sponheimer with Gabelli. Please go ahead.

Brian Sponheimer

Hi, Roger, Tony, and J.D.

Roger S. Penske

Hi, how are you Brian.

Brian Sponheimer

My question will be on regional differences during the quarter particularly in the Northeast as we headed into some -- as we headed into Brexit, any changes there?

Roger S. Penske

Well, I would say that if I looked at the business in the U.S. yes, we were down as we said just about 2%. DC Metro was strong for us. In fact Connecticut and New York really were up on new units and up on used. So, and that has been down. I think I have mentioned in previous calls that we had a little bit of pressure in the Northeast and the Northern California is strong and Texas I have heard a lot of conversation about Texas. And our truck business, heavy truck business in West Texas, in Midland, Odessa, and Amarillo, obviously we are seeing an impact there on new truck service and parts continues to be good. But if we look at our auto business even in Texas really we are talking about 200 stores in Houston and then of course for business in Austin and Round Rock continues to be good. So, overall for that market we were up 5%. That would be just a quick coverage. Obviously Florida has been good and Atlanta has been a strong market for us.

Brian Sponheimer

Okay, that's helpful. And you mentioned warranty -- can you remind us there was a BMW issue actually on the warranty side that may have caused a difficult comp for this year?

Roger S. Penske

Yes, when you really look at our gross profit in parts and service it is ironic when we are down I think 150 plus basis points. Basically we have more warranty in the UK internationally but we get less margin on warranty in the UK because we got a very small markup on parts. On the other hand in the U.S. our warranty was down and normally warranty has a better return both on the labor side and the part side and we have on customer labor. So, there was van hosed [ph] BMW engine retail on our overhaul and we had for BMW what’s really impacted us when you look at it year-over-year for the quarter. So, to me it is on a same store basis we were -- it cost just probably 100 to 150 basis points.

Brian Sponheimer

Okay, thank you very much. Nice quarter.

Roger S. Penske

Thank you.

Operator

And we will go to Paresh Jain with Morgan Stanley. Please go ahead.

Paresh Jain

Hi, good afternoon Roger and Tony. Couple of questions, so earlier today we had one of your peers talk about how they could get a lot more aggressive with acquisitions, it saw a decline 10% to 15% from here. Do you share that view and do you see something similar happening at Penske if that were to happen?

Roger S. Penske

Well, I think there is a number of people out there testing the market that probably who are interested in selling their business. But right now as I think it has been reported even by our peers that some of the expectations just don’t make any sense from the standpoint of being able to have growth even if you can commit and take cost out because lot of this business as we look at it have margin pressure. And that will create a negative to the bottom line. I don’t think there is less opportunities. I think on the premium luxury side, they are very expensive. There might be fewer.

And in some cases the manufacturers are now looking at sales efficiency and if you are not sales efficient with certain brands you can't make acquisitions. I think that has some of the not only public companies but also private people after having the standstill. But we see lot of activity in Europe and that is one of the benefits we have when you think about those markets over there with Germany up 7%. Italy I think was up almost 18% for the quarter. And Spain was up and those are areas that were very active and we see a lot of opportunity there. Multiples are certainly back to realistic numbers when you look at that opportunity versus what you might have here.

And then we are looking at our services business which is our heavy truck as we made this acquisition in Toronto and we'd love to continue to grow our heavy duty truck sales business. So, overall I think it is individually what you want. We are a premium luxury service so it is tougher and tougher to find those deals at reasonable prices here in the U.S. where there might be others that might be available. So, I think it is depending on what your mix is. I think we all have strong balance sheets so we can make those. We said that at the beginning of the quarter, I said what's the best action plan for PAG. We bought stock in Q1. This opportunity came up with GE from the standpoint of the Penske truck lease and we looked on the cash on cash return. We looked at the company, there are no people, no CAPEX, no vehicles and we can get this kind of return in the business. We already own a piece of it, it was the way to go. So, we would look at that to be a priority for us maybe in the next 12 months.

Paresh Jain

That's good color, and let me follow up on that Penske Truck Leasing deal. The business reasons are very clear, but if you could walk us through the reasons to increase your stake at this point in the cycle? And on the accretion math, your previous stake of 9% accounted for about 6% to 7% of pretax in 2015, and this additional stake of 14.5% is also expected to generate a similar kind of accretion. Is the rest of the difference mostly interest cost?

Roger S. Penske

Yeah, that would be right, yes.

Paresh Jain

Okay. And could you walk us through some of the reasons why increase the stake at this point in the cycle?

Roger S. Penske

Well, I think when you look at the business, we have core competency in transportation, in services, that way from the standpoint of being in the truck business. We built Penske Truck Leasing over the last 25 years. Well, it builds on our relationship with Daimler and Freightliner and I think as we look going into our logistics business on a longer term basis we can build on our OEM relationships from the standpoint of future business.

But on the other hand you look at the cash flow and you look at the benefit of the depreciation we will continue to be a profitable company with earnings, taxable earnings here at PAG and there is no question from a PTL perspective they purchase somewhere between $1.5 million and $2.5 billion worth of equipment each year. So we will always be getting that benefit and this is not something new in the internal revenue tax code. This is pretty much inconsistent when you have two years back and 20 years I think forward which you can utilize these tax benefits.

When we get the benefit of purchasing tires, fuel, oil, many of our abilities as we look at our buildings from the standpoint of insurance, there is a number of things that we can do together when we go out to build these things we get the benefit of the scale. We have also been able to use some of the people. We have cross-pollanized the people from the two organizations. So, together the two companies will have almost 55,000 people. So, we have a great network of talent that we can pull from and there is no question that we are expanding in Australia, PTL is expanded in Australia with us in the truck and distribution side.

Paresh Jain

That's great color. Thank you.

Operator

And we will go to Bill Armstrong with C.L. King and Associates. Please go ahead.

William Armstrong

Good morning Roger. I am sorry good afternoon Roger and Tony. On the heavy-duty truck side, your same-store unit sales were up 12%, which was surprisingly strong in light of how weak the overall heavy-duty truck market is, I was wondering if you could just kind of flesh out how you were able to generate that kind of increase?

Roger S. Penske

Well I think that we focused on conquest accounts in our earlier responsibility. And quite honestly as you know we bought that business in Tennessee and Chattanooga and Knoxville and part of Georgia and we were able to conquest covenant in U.S. Express which are two major accounts that the distributorship didn’t have in the past along with some glider business we got from Fitzgerald certainly in the Oklahoma area. So, I think it is just putting our management team together, our knowledge that with sharing it has been in this industry for a long time and I think overall we have been able to provide the proper support that these large truck lease want. And we think there is still significant growth for us.

And the customer service side of this thing is key and we are not afraid to invest in facilities. And I think that the team we brought on some very good people. We brought on a key guy from Volvo who was an expert in service process which is hoping to take our downtime for truckers to a very low level to give us better net promoters score and customer satisfaction. So, we think that this is a real opportunity and we will drive this because of our success on the service side. But remember I spent a number of years as the owner of the Detroit Diesel so lot of these customers I was calling on myself door-to-door to get business years ago and I am back doing the same thing which certainly as if conjunction with a team. Certainly the freightliner business premier has made a difference.

William Armstrong

Got it, and on the subject of parts and service, the parts and service revenue was actually down year-over-year, which was a little surprising, especially in light of the strong top line -- the strong truck sales. What is going on there and is there any cause for concern or were there any well kind of unusual events going on?

Roger S. Penske

Real easy because, as we take on these bigger fleets and they have higher volume they expect the lower pricing. So, it is just a matter of reflecting our margin based on volume, it is mix.

William Armstrong

Okay, thank you.

Roger S. Penske

Thank you.

Operator

Our next question is from David Lim with Wells Fargo Securities. Please go ahead.

David Lim

Hi, good afternoon gentlemen.

Roger S. Penske

Hi, David.

J.D. Carlson

Hi David.

David Lim

Hi, can you -- with all this whole Brexit situation and then discussions about U.S. sales, etcetera, could you sort of dive in into your flexible variable cost structure, I mean, how quickly can you guys flex down? Would you be able to flex down within a month or is it like one or two quarter thing, if you could sort of dimension that, that would be very helpful?

Roger S. Penske

Well, let's think a little bit, let's go to the top and think about the market. Today the market is about 2.6 million to 2.7 million vehicles and we are in the premium luxury side 95% plus. So, and that represents in the total market about 750,000 vehicles and we are running about 90% of that. So, maybe I think that we are looking probably at about in our case 6000 or 7000 vehicles if we have a 10% decrease. And remember we took 10% of our workforce out within four to six months during the financial crisis back in 2008, net inventory reduction. But I mentioned earlier on the call, our units in operation have grown substantially because I think Tony if I am right since 2008 the premium luxury has grown from about 17% of the market through this 25 or 26. So, we will get the benefit of parts and service. And remember from a PAG perspective only 9% of our revenue comes from parts and service and that I think that this will give us the chance if this continues to grow and the margin is about -- the gross profit is about 44%. So, to me if we can continue to keep that customer help us drive through if there wouldn’t be issue. Used vehicles also is an offset and remember in the UK we are over one to one new to used, used to new.

David Lim

Great, that's very helpful. The other question I have is what is your thought, Roger, on the U.S. sales outlook. I mean, we have been averaging I think, 17.1, 17.2 for the first part of the year. Any preliminary or any thoughts sort of at halftime on what your thinking is for the second half, especially after what Ford said today on their call? And something a little further out, I wanted to get your opinion on build to order as it relates to the dealers. Do you think the traditional OEMs, such as Ford, GM, whoever, could sort of move into that model more and more where a customer will come to the dealership or maybe even order through penskeautomotive.com and a vehicle could be at their -- delivered to your dealership maybe within the next 72 hours or so?

Roger S. Penske

Well, let me say this I have never gotten into a conversation on predicting the SAAR. Because when I do it, I have got to go down and look at my mix. And my mix is premium luxury. And we have seen fluctuations there and then we have got such a used car opportunity there that new cars are down. So, look I think 17 million, if we could have 17 million throughout the year, I think that is a great number. We can make a lot of money in the business with that level because I think once it levels off if it does, the manufacturers are going to have to understand that they can't be pushing too much inventory. Because when they do they got to pay incentives and those sales are up 12% I think for the month versus last year. And then they don’t just cost them money. So, I think that they will be rational on inventories because I think that is what Ford said today.

And leasing remember is an opportunity going forward because today it is only 31% of the business. On the premium luxury side, it is almost 50. So, as I look there is some opportunity but when you think about build to order, we build a lot of cars to order for people internationally. In fact they worry about cars that are in stock it might be something wrong and was interested in how we will find to change that mentality by having vehicles in stock internationally, to be able to grow the business. But I don’t think we can build a car in certainly two hours. I think you will be able to communicate with I think all of the public companies and many of the private guys are pretty smart here. They are going to have tools that you can either through the internet or through their capability or the net, you are going to be able to order a car, spec a car, and get the financing put together and they will deliver a car to your door and maybe you will sign the papers and do it electronically, who knows sooner or later. But I think it is going to be a little bit of time.

Unless there is pool stock and I still think pool stock wouldn’t have the specifics of what you might want to press the motor. It is probably like getting a custom suit versus one that you buy off the shelf. And I think with build to order and you said 72 hours I think it was pretty difficult. But it is certainly a way to go but I think we are in this with Wal-Mart and where they take at discount places people want inventory, they want their impulse blighters in the auto side. And I think we sell less, and less, unless it is a Porsche 911, Turbo, a Bentley or something like that as people would want to spec it out specifically. And remember we are a significant used car retailer so we will also look at this young used car channel as an opportunity. I know you can't really spec the car.

David Lim

Sure. Great, thanks for all the color. Thank you.

Roger S. Penske

No problem.

Operator

And we will go to Brett Hoselton with KeyBanc. Please go ahead.

Roger S. Penske

Hey Brett.

Brett Hoselton

Good afternoon gentlemen.

J.D. Carlson

Hi Brett.

Brett Hoselton

Let's see, I think I want to talk you a little bit about the M&A environment. One, kind of looking at the light vehicle M&A environment, but then also, secondly, the commercial vehicle M&A environment. So on the light vehicle side, can you talk a little bit about where the environment is internationally, obviously, U.S., Europe and then also obviously it seems as though there may be an opportunity down in Australia. I think you kind of talked about that longer term, where is your thinking out there?

Roger S. Penske

Well, let me say this, Australia right now I think we are looking at taking cost out in our truck distribution because ironically the average heavy truck here is six years old. It is almost 12 years old in Australia and New Zealand and we are seeing the market still going down. So I don’t think we are going to be making a lot of acquisitions specifically in the truck market. And I think the power systems business continues to grow. So, from a light vehicle perspective, I think Western Europe for us, we have OEMs calling us every single day with opportunities that we will continue to invest. There we are building our base in Germany, we are building our base in Italy, and certainly in Spain and we don’t have to talk about the UK that continues to be make acquisition of 11 stores of Lighthouse Group here in the last couple of months here. So, we see that continuing to be -- maybe our fishing area.

The U.S. continues to be more expensive. The premium luxury multiples are very high and I think that obviously if one is contiguous and we can see the benefit of not having a lot of CAPEX to do. We might reach somewhere higher to get something like that but I would say in order it would be Western Europe. Today, continuing the UK, watching the premium luxury in the U.S. but no question on the truck side. Freightliner we have a framework agreement with Freightliner that allows us to grow to a certain level and they are interested in seeing a number of the smaller operators or people who really don’t want to invest, sell their businesses and we have been fortunate. One of those was obviously just put together in Canada, in Toronto which is a city of 6.5 million people. I was amazed at the growth there and the opportunity. So, we are going to be very opportunistic with our capital. Then of course we have this additional 15% that we have to take a look at it on a longer-term basis from GE on PTL.

Brett Hoselton

Excellent, and then wondering what your thoughts are with regards to -- switching gears, talking about Brexit here. It seems as though the auto industry has dealt with currency fluctuations ad nauseam through the years. I think of the Japanese with the yen and I think of the German deutsche mark versus the U.S. dollar, etcetera, etcetera, etcetera. So it doesn't seem as though FX is necessarily, I mean, certainly disruptive in the short-term, but it doesn't seem as though the auto industry hasn't necessarily dealt with this. And I look at Toyota and Honda and so forth in the U.S. where yen has fluctuated all over the place and yet they have just regularly gained market share, and the German luxury brands have done the same. So, I kind of sit back and I look at the Brexit situation and I'm wondering how that might be different, and I am kind of struggling to see the significant difference between that situation and the other situations that I just mentioned here, do you have any thoughts on that?

Roger S. Penske

Interesting, I used the same example to people here in the last couple of days about Toyota and Honda. You know the yen has been all over the map with the U.S. dollar and they are having increased prices and they have gotten market share. So, you are right on. When you look at the difference between the pound and the Euro right now it is 8% is the change. But on the other hand remember, today the UK exports 800,000 vehicles into Western Europe and the Germans export 900,000 vehicles into the UK, it is the second largest market. So I would doubt if there is going to be a lot of fluctuation one way or the other. And to me as important as the market is and if China has been a little bit slower for them, they have the production. I am sure they don’t want to keep their plants going and ship those cars continually into the UK.

I really just -- I see maybe the impact to us is the pound devaluation against the dollars. We do our translation but I think that the most important thing you and I should do or we should do is sell a group on the people involved in this. Really take a pause here, August is not a good month to look at because it is preregistration which comes in September and we should wait and see what happens in September. That will give us a real true picture if there has been an impact. Right now we don’t see it being new up 3 and used up 5. It could take two years before we really get an answer.

Brett Hoselton

Excellent, thank you very much, Roger, and hopefully I will see you this weekend.

Roger S. Penske

Thank you. Yes, you will.

Operator

And we will go to Mike Montani with Evercore ISI. Please go ahead.

Michael Montani

Hey, J.D., Roger, and Tony. Just wanted to flush out a little bit, if I could, first on the Takata side, sorry if I missed this, but did you give the percentage of inventory now that is on stop sale?

Roger S. Penske

Yeah, when you look at overall for PAG and this is domestically. Internationally we really have very little. We have about 2200 used cars which is about 12% of our used car stock. And we have about 400 to 500 new. And we are managing through this. I think that what I said earlier on the call that it will probably take us probably 60 to 90 days to work it through. I think there is some good used cars in there that we can retail. And the overall inventory value of both the new and the used is about 57 million, 22 new and 35 used. We think we can complete week to week color here before the end of the year obviously. And I think we are halfway through the BMW.

Michael Montani

Okay, so in terms of getting the necessary airbags to do the replacement work, were you saying by the end of the year you think you would have those, Roger, was that --?

Roger S. Penske

I hope it is before that because they have been very good at supplying us support from depreciations, etcetera, etcetera. And I think you are going to see that sun set here shortly and they are going to do that based on availability. Now what we have to do is be sure that we are taking care of our customers that have cars, that have potentially air bag issues, we would do those first. Then of course we would do our own cars and inventory. The only one thing I said it earlier was that if everybody decides once they get the parts, the retailers decide to wholesale these cars that are going to hurt the value and the market but in our case we are going to retail them because there is some good cars for us from a stand point of opportunity from a used car supply perspective.

Michael Montani

So, I guess is it having any impact to the comp or do you think that consumers are just substituting other used units at this point?

Roger S. Penske

Well I would like to see our used car business fleshing out. We were off slightly for the quarter and it is not all just BMW. But I think it has had some impact on used especially in our Atlanta market where we were so strong on used cars. But I think if the customer wants to buy it, trust me, if someone come in and wants to buy a car and we have an inventory we are going to try putting in something else that would be certainly in my direction to the sales managers and sales force we have in place.

Michael Montani

Great, the last I wanted to ask about is front-end profitability, Roger. If you could talk a little bit about how you are thinking about that progression through the back half of the year, both the U.S. and UK?

Roger S. Penske

Well, today we got a certain amount of front-end profitability but we really look at the total gross profit of the transaction. And I think I mentioned earlier that if you take a new or used and F&I, we are up I think $43 across the business and I think that to me is what we are watching. And some of the money now because you get on the backside which used to be on the front is for CSI. Some of it is for facilities. So they really, you just can't look at the front-end of the car deal anymore. You got to look at really the total transaction and that is what we are doing. So, I am looking at total gross profit and I think the good news is as we look in our business from the standpoint of U.S. -- the U.S. operations there and certainly in the quarter, we saw some stability from the standpoint of gross profit. And I think that, that's key. I saw little or no deterioration of margin in used car -- excuse me in new cars in Q2 and that is I think because our guys are managing. In fact when you look at new cars they were up $100 per car.

Michael Montani

That's helpful. Thank you.

Roger S. Penske

Thank you.

Operator

Our next question is from Pat Archambault with Goldman Sachs. Please go ahead.

Roger S. Penske

Hi, Pat.

Unidentified Analyst

Yeah, hi actually it Dave on for Pat. I know it is a long call, lot of great details. Just one question on Takata airbag situation and the impact it might be having on the used market at this point. Are you seeing incremental bidding activity or competition for the actual used vehicles that are at auctions or in the channel coming back to you as a result of this i.e. is there more competition for less supply kind of holding up used values and residual values or you are not seeing that?

Roger S. Penske

I would be the wrong guy to answer that. I am trying to cluster my business but I can't tell you particularly and the market changes every day. But right now we have 10000 BMW that will come back during 2016 and when you think about that, that's real opportunity for us from a used car perspective. So, we are not buying many cars at the auction. We are trying to take the cars that come back from the leases which make a huge difference. And when you think about it on a year-to-date basis we have shown almost 11,000 used cars so you can think about that. A big portion of those or ones that were coming back off of lease -- some of those cars coming off of lease the customers buy and then some of them obviously we might wholesale because they have too many miles, etc.

Unidentified Analyst

Okay, well I will ask the other dealers and thanks Roger.

Roger S. Penske

Thank you.

Operator

Next we have David Whiston with Morningstar. Please go ahead.

Roger S. Penske

Hi, David.

David Whiston

Hi Tony. On Brexit, I don't know if you would be able to answer this or not, but I'm just curious how either perhaps terror sensitive or just consumer confident sensitive the UK fleet buyer and the UK consumer is, in other words, are there mixed concerns that you have on, say, a company that was only giving its employees, say, a 5 Series, they will go to a 3 Series, or a 3 Series person will have to get downgraded to a volume brand?

Roger S. Penske

That could be if someone has a concern but we haven’t seen that. I mean, I think we really have to look at the registration because as you know that market most people's compensation is part of that is with a vehicle. So, I don’t see that stopping from the standpoint of they might change models and they might do that just for a cost save. We might do that for people at a lower priced capitalized cost on a particular lease. But we haven’t seen that at this particular time. I really think it is too early and with the different opportunities and lease, the PCP over the -- I don’t think that is going to be an issue. What we did see though was that the leasing companies backed off on Audi and Volkswagen and Fiat and Skoda because of the diesel situation. Just from an integrity standpoint they kind of dropped some of that business to the other OEMs. We saw that directly in the U.S., excuse me, in the UK.

David Whiston

Okay, thank you. And on the PTL accounting with the increase in that stake was $0.25 per share, I am sorry if I missed this earlier if you talked about it, but of that $0.25, roughly what is the split there between a tax tailwind versus more equity income?

Roger S. Penske

In equity, what we will do is equity income if you adjust the cash, you get the benefit of the cash that you generate from the tax benefits that carry over from the depreciation on those assets. I will get Tony if you want to, to give you a call and you can ask him specifically rather than get into a lot of detail here on the call.

David Whiston

Okay, thanks so much.

Roger S. Penske

Okay.

Operator

And we will go to Carl Dorf with Dorf Asset Management. Please go ahead.

Carl Dorf

Hey Tony and Roger.

Roger S. Penske

Carl, how are you?

Carl Dorf

I am good, thank you.

Roger S. Penske

I haven’t heard from you in a long time.

Carl Dorf

We are analyzing more of you with stuff in the past -- and getting on it. Today I wanted to be on it. I got two quick questions. One, I like the truck leasing -- increase in the truck leasing deal. It has put your debt up to about 55% on the balance sheet, so I am curious what your attitude is relating to that, how high would you go, what plans do you have with that? And I definitely do like the increase in the dividend. I don't necessarily want you to stop that, it is only up to that payout ratio in favor of? My last question would be relating to the Australian business. With revenue down, you managed to increase the profitability. How did you accomplish that?

Roger S. Penske

Let me start with Australia and I think the benefit is that we had a truck distribution business that in 2014 was strong. We saw that deteriorate when we bought the power systems business and this is the Rolls Royce, MTU, Detroit Diesel off highway, marine, military, and naval business. And that business has been very strong. And we look for that to grow continually here over the next several years with some of the longer term contracts.

So, when you put the two together we showed an uptick which we think that will be a benefit to us as we look year-over-year by the time we end 2016. There is no question when you think about the dividend, I stated earlier we wanted to go 30% to 35% payout. So as the business ends money I would hope that the Board would continue to approve of dividend and dividend increase. From a balance sheet perspective and our debt to capital, with the profitability and certainly with the cash benefits we get out of the taxes is going to help us bring that ratio down. I hope to be -- we went from 2.5 to 3.1, I hope to be below 2 on EBITDA to debt will be under 3, excuse me, by the end of the year. So, we see as you know this business, it really generates cash and CAPEX becomes the only allowance with acquisitions and dividends that they will become -- we have to manage carefully.

Carl Dorf

Thanks. So, basically your goal is to bring it down from the 55 where it is right now?

Roger S. Penske

Right.

Carl Dorf

Okay, thank you very much, Roger.

Roger S. Penske

Carl if you look, we have been 41, 42 but I think we have been safe and secure because we want to look and see what are the opportunities and we could buy one dealership or two dealerships or three dealerships that would take a year to consolidate. Those were the PTL purchase. No people, there is no real estate. You put your capital up and we know the business. So, I think it is going to accelerate our profitability nicely as we go forward because we know the strength of that business and you look today, you look at Ryder and you look at PTL, you can see our numbers through growing our bonds. It is a very good business. But quite honestly the multiples in the truck -- in the truck leasing logistics business were better than ours so, they are going to help our stock.

Carl Dorf

Thank you.

Roger S. Penske

Thanks Carl.

Operator

And our last question will be from the line of Douglas Karson with Bank of America/Merrill Lynch. Please go ahead.

Roger S. Penske

Hey Doug.

Douglas Karson

Hi and thanks for hosting the call with all the detail. I have one kind of bookkeeping question. It looks like the transaction was about $499 million, which was I think funded on the revolver, partially, and partially through other liquidity. How does that set you up like for the next six months, does that balance stay on the revolver, do you consider terming that out, you had a successful bond in the market a few months ago, I was just kind of looking for kind of maybe timing on --?

Roger S. Penske

When you looked at it, remember we did the bond offering and we had -- we paid down a portion of our working capital line which was down to zero. We had almost 100 million just in the U.S. cash on our balance sheet and we had significant pay down of our floor plans. So, when you rolled it altogether I think as I said we went from 2.5 to 3.1 from a debt perspective and with the equity in the vehicles all we did was re-floor plan that we had all the room in the world to do that with the manufacturers.

Douglas Karson

Right, okay. That makes sense. Thank you for that extra color.

Roger S. Penske

Good, thank you.

Operator

And Mr. Penske I will turn it back to you for any closing comments.

Roger S. Penske

Alright, thanks for joining us today. We look forward to getting together after our September results. You have a good day and thanks.

Operator

Ladies and gentlemen that does conclude your conference. Thank you for your participation. You may now disconnect.

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