Penske Automotive Group: Getting Back On Track
Summary
- Penske Automotive made some impressive cuts to cost and debt during the pandemic.
- Penske's dividend suspension only lasted two quarters and is once again paying a growing dividend each quarter.
- The company has ambitious expansion plans for used car supercenters.
- Despite the huge run over the past year, the share price has lagged competitors and the stock is still a good value.
Speed Record For Dividend Reinstatement
I last covered Penske Automotive Group (NYSE:PAG) in June 2020 after it announced it would suspend the dividend to conserve liquidity in the pandemic. At that time I mentioned that I sold the stock (after it had doubled from the March 2020 crash lows) although I rated it Neutral in the article. This turned out to be my biggest trading mistake of 2020 as the stock has gained over 63% since publication. While I was able to replace the lost dividend income, I sacrificed a much larger total return. I estimate my total portfolio would be about 1.2% higher value today if I had not made that trade. For more discussion about the perils of chasing income, please see my most-read article on Seeking Alpha, "Don't Sell Potential 10-Baggers Just To Chase Income".
It turns out that the dividend cut was exactly what Penske needed to help stabilize the balance sheet. Long-term debt has fallen to $1.60 billion (1.7 times EBITDA) at the end of 2020 from $2.26 billion (2.7 times EBITDA) in 2019. Additionally, Floor Plan debt also decreased to $3.1 billion from $4.0 billion. Floor Plan interest expense went down by a much larger percentage due to the decline in short-term interest rates. 2020 Floor Plan interest was $46.3 million (1.5% interest rate) compared to $84.5 million in 2019 (2.1% interest rate). Finally, the company was able to cut SG&A expenses by more than the drop in revenues, leading to improved operating margins. Looking forward, cost will come back up as all dealerships reopen fully and sales increase. From the earnings call, however, Penske still expects the longer term SG&A run rate to be in the 73% - 74% range, about 3 to 4 percentage points lower than pre-2020 historical.
Source: Penske 4Q 2020 Investor Presentation
The recovery in auto sales from the pandemic was far faster than I anticipated in June helped by stimulus payments and a decline in public transportation and ride sharing. Total industry unit sales came in around 14.5 million in the US, compared to the 12.8 projection I had in my June 2020 article. For 2021, forecasts now anticipate around 16 million cars sold, up from the 14.9 projection in my June article.
The improved balance sheet and sales recovery allowed Penske to reinstate the dividend after only two missed quarters. It was restarted at the same rate in December 2020 and resumed its prior 1 cent quarterly raise with the March 2021 dividend.
Source: Seeking Alpha PAG Dividend History Page
Three Year Growth Plan
On the earnings call, Penske discussed plans to earn $1 billion of income before tax in 2023. For comparison, the company earned $708 million in 2020 and $592 million in 2019. This growth comes in three areas: Traditional car dealerships, commercial vehicles (both truck dealerships and leasing), and used car superstores.
...as you think about the growth between now and 2023, we're estimating about a billion in EBT. And I think they're really probably three areas. One would be our commercial vehicle business and transportation solutions would be - gross would be about 25% in that area. And then our organic growth would be - our US and UK businesses on the retail side would grow at 30%. And we'd have acquisitions, including our superstores at about 45%. So that gives you the three buckets of growth. I think when we look at the return on investment, we're seeing probably on the use car superstores will invest about 200 million, and we think the return on those would be about 30%. On the truck side, we probably see 20 to 25. And today, I think, if you look at it nationally, here at least in the US, I'm not talking about to UK, it's probably 10% to 15% return on capital. So we're going to focus for the right businesses giving us the right returns.
Source: Roger Penske, PAG 4Q 2020 Earnings Call
The car dealership expansions for 2021 include a Porsche (OTCPK:POAHY) dealership in Washington DC that opened in January. Currently under construction are an Audi (OTC:AUDVF) dealership in California and a Honda (HMC) outlet in Texas.
Penske's truck dealerships performed well in 2020 with new truck unit sales only off 5% (better than a 10% industry decline) but used truck sales up 95%. For 2021, Penske remarked that ACT is forecasting Class 8 truck sales to be up 25%. Penske is the largest dealer of Freightliner trucks and is looking to add dealerships as part of the growth plan. On the truck leasing side, Penske has customers like FedEx (FDX), UPS (UPS), and DHL that have seen increased demand from the growth in online shopping. Increasing fleet size will be a priority for Penske this year.
Used Car Supercenters
The used car supercenter business is probably the most ambitious of Penske's growth plans. Penske currently has 17 of these stores in the US and UK. The company is renaming the US stores to CarShop to create one global brand. Penske will spend about $200 million to expand this business to 40 stores by the end of 2023. Penske enjoys an advantage in supplying these stores because they have a steady source of high-end used cars from their predominantly luxury brand dealerships.
Penske has been investing in digital technology to enable end-to-end online purchasing from selection to scheduling a test drive to financing and home delivery. This is called "Preferred Purchase" in the US and "Click and Collect" in the UK. It has been employed largely at traditional dealerships so far but will soon roll out to the CarShop superstores. This should make Penske more competitive with online-only outfits like Carvana (CVNA) and Vroom (VRM) for younger customers who prefer the online experience or those who are still social distancing because of the pandemic.
Valuation
If Penske can deliver on its three year plan, it would represent a CAGR of 12.2% on pretax earnings. At a current price of $71 and 2020 EPS of $6.74, and forecasted 2021 EPS of $7.51, Penske has a trailing P/E of 10.5 and a forward P/E of 9.5. Whichever P/E you want to use to calculate the PEG ratio, it is below 1, which is very attractive.
Despite Penske's strong run since the March 2020 pandemic crash and its growth plans, the stock has underperformed every major peer except CarMax (KMX).
Source: Seeking Alpha PAG charting page
Penske is also cheap versus competitors on most valuation metrics:
Source: Seeking Alpha Peer Comparison Page
You will notice that Penske does not look as cheap based on EV/EBITDA in the above chart; however, the enterprise value used in the calculation includes floor plan debt, which Penske relies on more than many of its competitors. Floor plan debt is short-term financing from the manufacturer to help Penske maintain a sufficient inventory of vehicles. It does not impose a large interest burden, especially now when short term interest rates are low. Manufacturers also offset this interest by paying floor plan credits. In 2020 floor plan interest expense was $46.3 million and floor plan credits were $39.1 million, nearly totally offsetting.
If Penske was valued like the average competitor in the chart, it would be 15 times 2021 earnings of $7.51, or $112.65. Also, if the total return performance since the start of the pandemic could simply catch up to the average of Asbury (ABG), Group 1 (GPI), and AutoNation (AN), Penske would be worth $109.21. Finally, if Penske delivers its 3-year growth plan, it would earn $9.52 per share in 2023 assuming no change in tax rates or share count. A P/E of 12 which is the average of the FY3 P/E's in the above chart would value Penske at $114.24.
$112 seems like an ambitious price target after such a strong run, but it is reasonable if Penske can deliver its 3-year plan. The plan is new information as of last month's earnings release, so I believe it is taking some time for the few analysts who follow the company to accept it and build it into their forecasts.
Risks
Any pandemic-related delays to full dealership reopenings would be a headwind in 2021. Car sales in the UK fell significantly in January due to renewed lockdowns; however, since then, the country has been successful at delivering vaccinations.
Unexpected positives in the past year have been increased disposable income from stimulus packages, a trend toward more suburban living and away from public transit use. If the end of the pandemic reverses any of these trends, sales could slow.
Failure to execute the 3-year growth plan would be a risk, but Penske has an established history of expansions in the traditional auto dealership, commercial truck, and car superstore businesses.
Increasing electric vehicle share would be a risk to Penske's service and parts business, which earns an outsized portion of the profits at the dealerships. Electric vehicles tend to require much less service and parts than ICE vehicles. Perhaps the dealerships will have to develop other services they could offer such as detailing, customization, or software upgrades.
Finally, increasing interest rates would result in higher floor plan and long term debt interest expense, diverting funds from expansion or dividend growth. Based on the stance of the Federal Reserve and other central banks, I do not see short term rates rising for some time.
Conclusion
I recently repurchased Penske at $64.32 after selling it 8 months earlier at a lower price. That is not normally how I invest, but after observing the company strengthen its balance sheet, recover sales faster than the industry average, and release its 3-year growth plan, there appears to be plenty of upside remaining.
This article was written by
Analyst’s Disclosure: I am/we are long PAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (2)
Check out the number of analysts covering the latest period... maybe only a single analyst has Made an estimation with large deviations