- Despite a general trend higher, financial performance at Penske Automotive Group has been rather mixed as of late.
- Fortunately, things are looking up for the company and shares are priced at low levels on an absolute basis.
- There is some risk of weakness moving forward, which could hurt its value proposition, but even then shares are likely no worse than being fairly valued.
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In an era where there are almost as many cars on the road as there are people in the country, it is imperative for there to be some means for individuals to acquire those cars. Enter the industry known as automotive retail. And what better company to consider buying into in this space then one of the largest focused on the automotive and commercial truck retail markets. This is a company called Penske Automotive Group (NYSE:PAG), and prior to the COVID-19 pandemic, the company had demonstrated steady and consistent revenue growth.
Despite a temporary downturn, revenue and profits have skyrocketed higher this year. This has been spurred on by a couple of factors, but the bottom line is it has presented investors with something of a quandary. On the one hand, shares look incredibly cheap on a forward basis. But on another, there is uncertainty over whether the improved market conditions will only be temporary. In the former case, shares have a significant amount of upside potential. But upon a reversion back to less appealing levels, shares are probably more or less fairly valued.
Understanding Penske Automotive
Today, Penske Automotive is a giant in its space. According to management, the company is the second largest player in the market in the US. The company engages in a couple of core business functions. For the most part, it is involved in the sale of retail automotive goods. Through this, the business engages in the sale of a variety of vehicles, with 71% of its automotive revenue coming from the premium and luxury brands that it sells. Its largest brand exposure is to BMW. It generated 23% of its revenue from the sale of those vehicles in the past six months. Next in line are Audi and Toyota at 12% and 11%, respectively. It is also worth noting that while 45% of the company's retail revenue comes from new vehicles, used vehicles are not far behind at 38%.
Penske Automotive Operates 323 retail locations. Of these, 304 are franchised dealerships and 19 are CarShop SuperCenters. The company also has 32 collision centers to its name. All of its locations are split between the US, UK, Germany, Italy, Spain, and Japan. On top of this, the company also has another segment dedicated to the sale of commercial trucks. In fact, the company is the largest dealership group for Daimler Trucks N.A. in the country. Geographically, around 60% of revenue comes from sales completed in the US. The UK is in second place at 31% while Germany and Italy make up a combined 6%. The Australia, New Zealand, and Pacific region accounts for just 2% of sales, while Canada is responsible for the remaining 1%.
In addition to these more traditional operations, Penske Automotive has other businesses that it owns or owns a part of. For instance, it currently owns a 28.9% interest in Penske Transportation Solutions. This particular company has over 330,000 vehicles on the road today and in the last six months it generated sales of $5.29 billion. This compares to the $4.23 billion achieved the same time a year earlier. Profits in the past six months totaled $540 million, with $156 million of this coming to Penske Automotive. This represents an increase over the $44 million achieved the same time last year. The company also owns a portfolio of digital solutions. The latest of these is a platform called CarShop. This is part of a venture with Cox Automotive to allow consumers to purchase there are cars online.
Prior to the COVID-19 pandemic, Penske Automotive had exhibited steady and consistent revenue growth. Revenue expanded from $20.12 billion in 2016 to $23.18 billion in 2019. But then, in 2020, it dropped to $20.44 billion. Fortunately for this year, things are looking up. In the first half of 2021, revenue came in at $12.76 billion. This compares to the $8.66 billion achieved in the first half of 2020. Much of this revenue growth came as a result of the number of new and used vehicles being sold by the company exploding higher. In the second quarter of this year alone, new unit sales totaled 57,622. This is nearly double the 30,088 units sold in the first half of 2020. Used units, meanwhile, jumped from 41,952 to 73,270. It is also worth noting that retail truck units have also been on the rise, climbing from 2,063 for new vehicles in the second quarter last year to 2,770 this year. And used units increased from 773 to 803.
Though the trend for revenue has been fairly consistent, the same cannot be said of profitability. As you can see in the chart above, there is no discernible trend from here to year. However, it is important to note that profits are consistently positive. The same can be said of operating cash flow and EBITDA karma with the latter of these being the only one demonstrating consistent upside year after year. So far this year, net income has jumped from $96.8 million to $521.4 million. Operating cash flow surged from $784.4 million to $916.7 million. And EBITDA jumped from $249.2 million to $808.4 million.
There is a great deal of uncertainty moving forward as to whether the surge and demand and the stronger pricing caused by supply chain problems will continue to benefit the company or if it will ultimately hurt the business. One source, for instance, estimated that in the third quarter this year, nationwide car sales are down by as much as 14%. This is driven in large part by a shortage in semiconductors. That decline year over year was most severe in September when it was between 24% and 26% compared to a year earlier. More likely than not, the number of units sold by companies such as Penske Automotive will suffer, but the supply chain problems may allow it to generate larger margins from each sale. It is too early to tell the full impact.
Pricing PAG is tricky
It is because of this uncertainty that pricing the company is tricky. If we extrapolate results seen so far in 2021 to the rest of the year, the company is trading at a forward price to earnings multiple of just 2.8. This compares to the 14.9 if we use the data from the 2020 fiscal year. The price to operating cash flow multiple would be 5.8 compared to the 6.7 achieved last year, while the EV to EBITDA multiple would stand at 3.9 versus the 12.7 experienced in 2020.
To put all of this in perspective, I decided to compare the company to the five highest rated of its peers as defined by Seeking Alpha's Quant platform. On a price to operating cash flow basis, these companies ranged from a low of 3.4 to a high of 9.2. The 2021 figures make ours cheaper than all but two of the four companies, with a fifth business being a clear outlier. If we use the 2020 figures, however, our prospect is the most expensive of the group. I then did the same thing using the EV to EBITDA approach, ending up with a range of 3.8 to 9. Of the five companies covered here, only one was lower using the 2021 figures, while the 2020 figures made ours the most expensive of the group.
At this moment, Penske Automotive is a difficult company to understand. On the one hand, shares of the business look incredibly cheap if you assume that this year is any indication of the company's long-term potential. More likely than not, the company will recover, and will then grow at a steady pace like it did prior to the pandemic. Using the 2020 data, shares look awfully pricey compared to the competition, but don't look particularly expensive on an absolute basis. And it is unlikely that the long-term picture would look worse than that year did. So, in the best case, shares have meaningful upside potential, while in the worst likely case, shares are probably more or less fairly valued. This makes for an interesting risk to reward payoff for investors to ponder.
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This article was written by
Daniel is an avid and active professional investor.He runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein. Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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