Penske and Auto Retail: Not Signaling Consumer Weakness and the Market Agrees
Excerpt from Footnotes and Flashbacks: Week Ending Feb 10, 2023
As we wrap up a week that had somewhat of a cap goods and auto theme, we look at what Penske Automotive Group had to say when they reported earnings. Penske is one of the better operators in a franchised dealer space that is growing, consolidating, diversifying and evolving business models. In degrees that vary by operator, that expansion includes Finance and Insurance Products (F&I), used cars, and digital retailing. The peer group is engaging in tactical M&A and bolt-on deals as more private dealers (which is the majority of dealers) monetize their franchises in a business that is growing more complex than ever and where scale will matter in areas such as digital retail and keeping up with OEM demands on EV planning.
Penske boasts the largest market cap of the major franchised dealers at $10 bn ahead of #2 Lithia and #3 AutoNation, #4 Asbury, #5 Group 1, and #6 Sonic. CarMax is in a world of its own as a dedicated used car dealer with the largest market cap in the retail group at $11 bn even after its 1/3 drop this past year. The used car business went from very lucrative to risky in earnings as well as presenting a strategic execution challenge. The franchised dealers are showing those headwinds in their 4Q22 earnings. In the case of Penske and some others, the disclosure is very granular by retail product lines across the full array of revenue and margin mixes. We will be doing more issuer level drill downs on these names separately soon enough.
In the above chart, we update the trailing stock returns for the peer group of franchised dealers and the two used car headliners in CarMax (KMX) and Carvana (CVNA). We looked at the used car dynamics in the fall as that subsector of retail sales heated up as a focal point (see Market Menagerie: The Used Car Microcosm 11-29-22). With used car inflation going through radical swings in 2021-2022, the operating strategies of the dealers were getting more scrutiny as they were going through radical change. That picked up further as CNVA went into a freefall from its perch with a stock price of $370 in Aug 2021. With its massive % rally in recent weeks, CNVA is back to $10.84 on Friday close (see Carvana: Wax Wheels 12-8-22)
We see very strong returns vs. the broader market for most all the Big 6 with the exception of Lithia (LAD) looking back one year. LAD ran past the peer group into 2021 with its strategic priorities on used cars and digital retailing. LAD had run ahead as CVNA was spiking off the charts and investors looked for other less speculative exposures with some of that flavor. LAD is back in action now but with the “normal” peer group and all are being treated optimistically by the market after two years of tight new car supply. As we covered in the Macro section above, available inventory and better supply chains (but still constrained by chips) got Jan 2023 SAAR into the high 15 mn handle. That was a good start.
The 2022 numbers bode well for the ability of Penske to pursue its operating strategy to acquire and invest and deploy free cash flow. The main drag on revenue and earnings growth will be used cars and cyclical questions in their truck business. Overall, in 4Q22, PAG weighed in with record results for the year and solid margins. The results highlighted sharp declines in used volumes and margin pressure there, but used cars are not what drive the Penske story despite expansion in used car retailing in recent years.
The company is very well diversified with a heavy mix of premium brands and luxury. Penske has historically kept very low exposure to US brands. The largest brand is BMW followed by Audi, Toyota, Mercedes, Jaguar, and Porsche for almost 3/4 of dealership revenue. If we toss in Honda/Acura, Lexus, Maserati, and Bentley we get to 85% (so much for pickup trucks, although it should be made clear that Roger Penske oversaw successful NASCAR teams in addition to his own Formula One background. He is not a snob).