Group 1 Automotive Inc (GPI) 2020 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Group 1 Automotive's 2020 Third Quarter Financial Results Conference Call. Please be advised that this call is being recorded. I would now like to turn the call over to Mr. Pete DeLongchamps, Group 1's Senior Vice President of Manufacturer Relations, Financial Services and of Merit. Please go ahead, Mr. DeLongchamps.

Thank you, Christie, and good morning, everyone, and welcome to today's call. The earnings release we issued this morning and a related slide presentation that include reconciliations related to the adjusted results that we'll refer to on this call for comparison purposes have been posted to Group 1's website. Before we begin, I'd like to make some brief remarks about forward-looking statements and the use of non-GAAP financial measures. Except for historical information mentioned during the conference call, statements made by management of Group 1 Automotive are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve both known and unknown risks and uncertainties may cause the company's actual results in future periods to differ materially from forecasted results. Those risks include, but are not limited to, risks associated with pricing, volume, conditions of markets, adverse developments in the global economy as well as the public health crisis related to the COVID-19 virus and resulting impacts on demand for new and used vehicles and related services.

Uncertainty regarding the duration, severity of COVID-19 and its impact on U.S. and international authorities to ease current restrictions on various commercial and economic activities and uncertainty regarding the timing, pace and extent of an economic recovery in the U.S. and elsewhere from the unknown current and future impacts of COVID-19 and unknown future impacts of oil producers and the effect such can have on travel, transportation, oil prices, which, in turn, will likely adversely affect demand for our vehicles and services. Those and other risks are described in the company's filings with the Securities and Exchange Commission over the last 12 months. Copies of these filings are available from both the SEC and the company. In addition, certain non-GAAP financial measures as defined under SEC rules may be discussed on this call. As required by applicable SEC rules, the company provides reconciliations of any such non-GAAP financial measures to the most directly comparable GAAP measures on its website. Participating today with me on the call, Earl Hesterberg, our President and Chief Executive Officer; Daryl Kenningham, our President of U.S. and Brazilian operations; Daniel McHenry, Senior Vice President and Chief Financial Officer; and Michael Welch, our Vice President and Corporate Controller. I'd now like to hand the call over to Earl.

Thank you, Pete, and good morning, everyone. I'm pleased to report that for the quarter, Group 1 generated all-time record adjusted net income of $129 million. This equates to adjusted earnings per share of $6.97 per diluted share, an increase of 131% over the prior year's adjusted earnings per share. As mentioned in our pre-release earlier this month, our adjusted profit results exclude a $3.3 million pretax loss related to the redemption of our previously issued 5% notes due in 2022. Daniel will cover this transaction, along with our balance sheet and liquidity position later on the call. These results were a continuation of the very strong profits we've generated in May and June after the lockdowns began being lifted. And once again demonstrated the resiliency of our business model, the brilliant efforts of our employees. The major factors driving our major profit improvement are large new and used vehicle margin improvements and substantial cost leverage across our company. The first time since the U.K. voted to leave the EU, our U.K. operations made a significant contribution to our quarterly financial results.

We're very optimistic that this level of performance will continue as we have implemented a major restructuring of our U.K. operations to begin even before the pandemic. The extreme shelter-in-place orders beginning in late March, in both the U.K. and U.S. markets, required us to reduce headcount by 90% and 50%, respectively. During this time of dramatically lower business levels, we restructured both operations with the goal of improving our sales and service efficiency by at least 20%. We believe we're well on the way to achieving this. Current headcount levels in the U.K. and U.S. are both approximately 25% below pre-pandemic levels. As Daryl will detail shortly, vehicle sales volumes in the U.S. remain well below last year's levels, primarily due to low inventory levels. However, our same-store U.K. new vehicle sales increased of 11%, and used vehicle sales were up 14%. Our new vehicle sales improvement was influenced by below-average sales in the prior year's quarter due to shortages associated with the change in new vehicle emissions regulations. But overall, the U.K. market has recovered nicely throughout the summer. This can be evidenced by our same-store used vehicle sales increase of 14%, and our parts and service revenue increase of 4% in local currency during the third quarter. The volume improvements as well as large increases in vehicle sales margins, drove a 26% increase in U.K. same-store gross profit on a local currency basis.

New vehicle margins per unit improved 14%, while used vehicle margins were up 90%. This powerful gross profit growth of 26% was achieved while actually reducing SG&A expenses by 12%, resulting in an SG&A percent of gross profit metric of less than 61% by far the best performance in Group 1 entered the U.K. in 2007. To provide some color on our U.S. and Brazil performance, I'll now turn the call over to Daryl Kenningham.

Thank you, Earl. A number of factors contributed to our outstanding U.S. third quarter results, mainly, new and used vehicle gross profit growth, F&I PRU growth and strong SG&A discipline. Due to tight new and used vehicle supply, same-store new vehicle unit sales decreased 16%, and used vehicle unit sales decreased 13% versus the prior year. New vehicle inventories finished the quarter nearly identical to the second quarter at roughly 17,000 units, a 52 days supply. Our team did a fantastic job staying disciplined on gross margin. Our new vehicle improvement far outweighed our volume decline as a more than $1,000 increase in same-store gross profit PRU, generated a 34% increase in new vehicle gross profit. Although our new vehicle unit volume was down 16% in the quarter, it improved significantly throughout the period, as September sales were down only 3% from the prior year and up sequentially versus August. Our used vehicle cadence was nearly identical with new, and our PRU improvement drove a 27% total used vehicle gross profit increase on a same-store basis.

Our used car PRU performance was enabled by improved sourcing as well. Our sales sourced through trades and individuals were up 16% and vehicles purchased from individuals was up 93%, both are records for us and we expect to build on this improvement going forward. The second major driver in the quarter was F&I. Despite the decline in same-store unit sales, our record same-store F&I performance of $2,041 allowed us to maintain prior year F&I gross profit levels. The record PRU performance was driven by higher penetration and income per contract in basically all of our product offerings. The third major factor driving our outstanding profit performance was cost discipline. As discussed on last quarter's call, in the second half of March, we were extremely decisive and took aggressive cost-cutting actions in all 3 of our markets to protect our company's viability during an unprecedented economic environment. Throughout the second and third quarters, we've witnessed how resilient and productive our employees could be in this very challenging environment. We've modified our productivity targets in the third quarter, and we generated 93% of prior year's revenue with 75% of the headcount. This drove adjusted SG&A as a percentage of gross profit to a record 59.0%. While we don't expect this level to be sustainable, we do expect there to be meaningful improvement going forward compared to 2019. Also, we are encouraged by our aftersales gross profit performance. While the quarter was down 4%, this was due primarily to declines in the collision business. For the quarter, our customer paid gross profit was up and warranty was flat, and we saw very strong sequential growth of 23% from the second quarter. And we're very pleased with our exit rate, as our total aftersales business was up in September over the prior year. We expect to return closer to 2019 levels as we move into 2021. The before I touch on Brazil, I'd like to take a minute to update you on Acceleride, our digital retailing initiative. We continued our upward trajectory in the third quarter by selling over 3,100 vehicles through Acceleride. Customers choosing Acceleride close at a much higher rate than other customers. And additionally, to allow customers to access Group 1's digital retailing platform wherever and whenever they'd like, we've now launched acceleride.com. This platform includes among its many features, the ability for customers to sell us their vehicles remotely. Customers taking advantage of this feature, received a live bid on their vehicle and will soon have the option to receive a quick electronic payment.

Now turning quickly to Brazil. Despite a 22% decline in new vehicle industry sales, our team did an admirable job growing margins and aggressively thinning the cost structure in order to realize a solid quarterly profit. SG&A as a percentage of gross is 80% is the second-best quarterly performance over the 7.5 years of Group 1's ownership and positions the region nicely for a sales rebound coming out of the pandemic. I will now turn the call over to our CFO, Daniel McHenry, to provide a balance sheet and liquidity review. Daniel?

Thank you, Daryl, and good morning, everyone. As Daryl previously mentioned, during the quarter, we redeemed all $550 million of our outstanding 5% notes due 2022. This redemption was funded with $550 million of newly issued 4% notes due 2028. The along with the April redemption of our 5.25 notes due 2023, we now have no material debt maturities before our U.S. credit facility matures in June of 2024. Also, the debt restructuring undertaken this year will save us over $15 million in annual interest expense. We are very proud of the fact our company is in such a strong balance sheet position, given the economic challenges the world has faced in 2020. Turning to liquidity and cash flow. As of September 30, we had $66 million of cash on hand and another $127 million that was invested in our floorplan offset accounts, bringing total cash liquidity to $193 million. There was also $273 million of additional borrowing capacity on our U.S. syndicated acquisition line, bringing total immediate liquidity to $466 million as of September 30. We also have roughly $175 million in U.S. and U.K. real estate available to mortgage, which brings another $140 million of near-term liquidity, increasing the total to over $600 million. Our cash flow remains very strong as we generated $121 million of operating cash flow in the third quarter.

This brings our year-to-date adjusted operating cash flow to $358 million. This cash generation has been partly used to reduce our nonfloor plan debt by $159 million since the end of 2019. Also, our U.S. credit facility rent adjusted leverage ratio was reduced to 2.5x at the end of September, down from 3.3x at the end of 2019. Going forward, our preference for capital allocation is to add scale to our company through M&A. While the U.S. is our preferred market at the moment, we are open to acquisitions in our foreign markets as well, given the right opportunity. Absent suitable acquisition targets, we are certainly open to returning cash to our shareholders, as evidenced in our recent announcement of $200 million share repurchase program and the intention of reinstating our dividend in the fourth quarter. For additional detail regarding our financial condition, please refer to the schedules of additional information attached to the news release as well as the investor presentation posted on our website. I will now turn the call back over to Earl.

Thanks, Daniel. Related to our corporate development efforts, earlier this month, we disposed of the Nissan franchise in Mississippi. This is our first buy-sell activity of 2020 as we've been much more focused on our organic operations given the pandemic. As Daniel mentioned, however, we are now once again looking forward to growing our company through M&A. We've seen increased activity and potential deal flow recently, which is an encouraging sign. This concludes our prepared remarks. I will now turn the call over to the operator to begin the question-and-answer session. Operator?

(Operator Instructions)

And our first question comes from Mike Ward with Benchmark.

Firstly on the variable growth, on the new vehicle variable gross, can you talk about maybe the gives and takes of what happens on profitability when inventory is tight? The carrying costs go down, you get positive price, but are there -- what are the gives and takes? You lose some sales?

Well, when inventory is tight, yes, we obviously lose sales. And in the case of the quarter, Toyota is our largest brand and then also happened to be our tightest inventory as well. So yes, certainly, you do -- that can cost you some business when we operated about a 30-day supply during the quarter and most of many of our brands.

Okay. Now you kind of alluded to that in the press release as it relates to SG&A costs as a percentage of gross, that's one of the things holding it down. So if inventory doesn't get replenished until -- well into the second quarter. Does that mean that we could probably see the type of thing where you trying to continue these type -- this type -- or close to this type of performance in the 6s as we head into the first half and possibly even to the second half, is that what we're looking at?

Mike, this is Earl. Yes, directionally, that's correct. Operators are very savvy. When they cannot replace a vehicle, they don't sell it as cheaply. I mean that's the simple thing. They know whether they can trade with another dealer, they know if they can replace it. So that's driving these high margins throughout the industry. And the ramp-up and supply from the OEMs has been far below what anyone in our sector would have expected. We're just now starting to receive a few more vehicles and we're retailing every month. But our new vehicle inventory year-over-year at one point dropped something like 12,000 units. So we were still nowhere near back to normal levels and I'm sure we're not the only one. So while the reduction in margins going forward will be proportionate to the increase in inventory. There still appears to be a long way to go before the industry is back to normal new vehicle inventory levels.

On the service side, the chart on Page 12, that kind of goes through with these alternate energy type vehicles on the service side. And it sounds like it's a chance for the -- particularly the big well-capitalized dealers to gain share on the service side as the market moves towards more of these vehicles. Any idea -- I guess it's too early to tell, but could you basically have the service on those vehicles for the life of the vehicle rather than seeing a dramatic drop-off in years 3 and 4?

Potentially, yes. I mean, that's certainly true. What's definitely true is those vehicles take more investment from -- and franchise dealers are in a much better position to do that, whether that's training or equipment.

Yes. Mike, this is Earl again. And I think we've seen that same thing with luxury brand vehicles over the last decade. As they got more complex electronically, the retention levels and the customer loyalty levels on those brands has been much higher than volume brands. And so the electronic complexity which will now kind of extend into the battery power world just gives us a much stronger competitive position to maintain a higher percentage of the customer service business regardless of the age of the vehicle.

And our next question comes from John Murphy with Bank of America.

Just had a first question on the SG&A, I mean, how you're talking about -- with this really 20% improvement in sales efficiency means. I mean as we look at the workers that have been brought back. It looks like you're talking about 25% are still out. Could those folks stay out even if sales recover? And that's kind of how you're thinking about getting that efficiency? And what exactly you mean by that 20% sales efficiency? And is it really just mean that those 25% of the workers don't come back?

Yes, John, this is Earl. I believe we'll have to bring a few more people back because, as you can see, our volumes are a bit more depressed just because we were short on inventory. But the way we have structured the business now is toward a certain efficiency level for both salespeople and techs, and we believe we're in a materially different place than we have been before. The way we've structured our support functions and that our sales per salesperson and tech efficiency are going to be more than 20% greater than what we've had in the past.

So yes, I would expect some people to come back, but to be strictly volume related not support related.

Okay. That's very helpful. And then a second question, I mean, it looks like the October sales rate is going to be high 16s, it might actually breach 17, we'll see. This recovery in the U.S. is very remarkable, particularly given that fleet is a waning component of it. So Earl, I mean, how do you think about the durability of this recovery? And how much sort of pent-up demand from the depressed months of March, April, May, in June and July, they're coming back here? And how do you think about this at this point? Because it's going to matter a lot for how you shape your business in the coming quarters?

Well, the durability has been surprising to me, John. And as time goes on, I have more and more confidence that it's going to be sustained. And you've heard some chat in the last week or so. It does seem that people like their safe cocoon in their car. And in the U.K., we see it even more as people are shying away from trains in the tube and so forth for commuting to work. And interest rates are still low, incredibly low. So affordability is good. And so I don't see anything on the horizon that is going to disrupt this current situation where we have supply behind the band and solid demand. So we've got a pretty good runway, it would seem, at least through the winter end of the spring, for sure.

Yes. It's a remarkable backdrop. It's great. And then just lastly, Earl, I mean M&A has not been a key focus, certainly not off the table in the past. But it sounds like you're turning the tap back on what seems like a fairly material way. So I'm just curious what's changed in the business or in the opportunity set of acquisitions? It's really created this shift back towards M&A.

Well, I think it's the financial strength of our company, again and the stability in our operations. I think we've got them lean down to a very large degree and we can now integrate more quickly. And we can get more leverage from expanding our company and buying dealerships, particularly that may not necessarily be performing at the same level we are.

And our next question comes from Rick Nelson with Stephens.

Nice quarter, guys. Can you just Earl or Daryl about supplies, when you think the timing is of those normalizing and the implications for GPUs? Do you think we go back to pre-COVID levels or do we normalize at higher levels? And can you grow EPS in 2021 absent acquisitions or stock buybacks?

Rick, this is Daryl. I'll answer the first part, and then I'll ask Earl to address the EPS part. But on the inventory growth, we may see a little bit of growth in the fourth quarter, but it will be modest. I really expect we won't see our inventories materially improve until the first quarter of next year. And everything that we see is on the new vehicle side that the gross margins are very stable right now, and I would expect that to continue until the inventory situation materially changes.

Rick, this is Earl. Relative to growing EPS. I mean, we all know that's going to be a huge challenge given what's happened this year. But we've got 3 mitigating factors that we can lean on. One is, as we've discussed, we can do more volume than we've been doing in these market conditions because we've been constrained on new and used. So to some degree, I think we can mitigate any tempering of margins with more volume. Our service business is still not quite back up with previous year levels and that's not been a strength of our company. So I think we can get more out of service next year. And the third thing we have is, I believe we're going to get -- continue to get more out of our U.K. operation. The U.K. market is stable. And we've had a chance now to really rationalize our U.K. operation. We had added about 3 different dealer groups to our company at about the time of the Brexit election, couple of years ago. And we never really got properly integrated and structured, which we have done now.

So those are the 3 things that we're going to lean on to see if we can keep the company moving forward.

That makes sense. And of course, you got buybacks, some acquisition opportunities. The U.K., you saw outsized growth there relative to the market? I realize compares were relatively easy. But if -- what were the drivers there? And what are you seeing in October here as the risk traction seem to have been elevated over there?

Yes. The pace in the U.K. is still strong. Now it's a more seasonal market than the U.S. So after the September plate change month, you don't have quite the volume, particularly in November, December that you would have in the U.S. but it's still a healthy market. And I would say it's -- the order take rates have decreased a little bit, but no more than we would normally expect from the seasonality. So it's still a market that can produce for us at these levels.

Great. And finally, if I can bring, Pete, into the commercial section. F&I per unit is $2,000 leads the sector. How much opportunity do you see from here? And how important do you think these low-interest rates have been in driving that number? And if rates start to rise, is that, in fact, vulnerable?

So Rick, thanks for the question and thanks for noticing. It was a red quarter for us. And clearly, interest rates are a tailwind. And what it helps us do is we had really terrific traction, as Daryl mentioned, with selling service contracts and maintenance agreements. So just about every product that we offer was up for the quarter. Going forward, from a modeling standpoint $2000 is a pretty admirable number. And I'm hoping not to go backwards next year, but we've been able to have upward trajectory for the last 7, 8 years. So I think kind of keep it steady for now, and we'll continue to keep doing everything we can to provide these services for our customers.

And last question comes from David Whiston with Morningstar.

On the U.K., you said it's recovering nicely. And I'm just wondering if the worst case, no-deal Brexit does play out and that causes some havoc in the U.K. next year, do you think there's such massive still pent-up COVID-related demand in the U.K. that it could perhaps offset a lot of that Brexit headwind?

Well, it's hard for me to say that. This is Earl, by the way. There could be some disruption at the end of the year. There's this potential that there could be something like 10% tariffs on the cars coming into Europe. But what we have found in the past is the auto market in the U.K. is quite resilient. And a big part of our rent in the U.K. remains used cars and service and we would see that in being steady. And the new car bit is what could be disrupted. Well, which isn't ideal, but again, there's -- that the U.K. market has been very strong over time and has shown itself to be very, very flexible. The beauty of the U.K. market and the U.S. is the channels no longer stuff, right? The distribution channels in the U.S. and the U.K. tend to get stuffed over time with excess cars. And when they lean out is when you can really see the power of the used car business. And that's why our margins have gone up so much in the U.K. And I think any disruption to the new car business in the U.K., which could occur from whatever the trade situation is between the EU and the U.K. is likely to only make the used car market better.

Okay. And in terms of headcount and globally for you guys, have there been eliminations, permanent eliminations of any service technicians?

When we started this, we made a -- I guess I'd call it a strategic decision that we were going to transition from hourly technicians to flat-rate technicians in the spirit of trying to put as much productive workforce in our dealerships as we could. So we did reduce the headcount of technicians, and it was hourly technicians, and we're in the process right now of replacing them with flat-rate technicians.

So you're saying maybe, in aggregate, you wouldn't have a net reduction in technicians?

Certainly, over time, that's true. Yes.

Okay. And I'm interested in hearing, especially from you guys being Texas-based about the premium BEV Pickup segment that now has the GMC, Hummer and an addition to a lot of start-up manufacturers. And the Texas pickup from customer, are they really excited about something like the Hummer? Or do they still want an ICE truck? And do you just see this being the domain of wealthy consumers?

Right now, we have some GNC stores in Texas. The reaction from those customers on the first version of the Hummer has been very positive. They're going to roll that truck out over a 3-year period with 4 different grade levels. So I think the true test will come when we get out of the $120,000 truck and down into the one that transacts into the $60,000, $70,000 range. So the early ones were received very positively.

Are you worried at all about any cannibalization with the Denali trim?

Not at this point, not at this point. It's early, it's too early to tell.

Okay. And just real quick on service. Is that really just a function of people aren't driving many miles because of the epidemic and once the miles pick up, you'd expect business to come back? Or do you think that consumers are just still staying away from your stores for service because of the pandemic?

This is Daryl. What we saw was our customer pay business has returned basically to where it was a year ago. Warranty was basically where it was a year ago. So I think it was miles driven. And I think as these trends continue, we'll see the momentum that we had previously come back.

And we an additional question from Rajat Gupta with JPMorgan.

There was a lot of discussion on the new supply side. Could you give us a sense of where the supply is on the used side and how that's coming back? You expect tightness there to continue similar to the new side of things? Or does that come back faster? And then relatedly, how does that influence your volumes and GPU here going forward?

Rajat, this is Daryl. The new side, I think we've been clear on that. We expect those to really not seen any material improvement until the first quarter. On the use side, our inventories have been lighter than what we would like because once the auctions did open, we tried to be very judicious with auction purchases. We've tried to limit our auction purchases. You saw in the quarter that we increased the number of vehicles we're purchasing from individuals as well as increase the number of vehicles we're trading for. And so that may have had an effect on our total used car inventory, but we feel like that's the right trade off. We feel like sourcing vehicles at auction is the worst place we can go and even right now, that's certainly the case. So some of that is a conscious purposeful change that we've made.

Got it. I mean, is that like -- but is the supply situation has it gotten better? Or is it like -- is it likely to get better here than the rest of the year or is that pretty similar to what you're seeing to (inaudible)?

I think it improves. As you've seen the new car volumes improve. You saw the SAAR in October is going to be very good and what you can assume from that is that we're going to get more trades. And that's our highest and best-used car inventory. And so yes, we expect that would improve.

Got it. And just a follow-up on Acceleride. I mean, clearly, strong growth rate there on the volumes, nice pickup, although still a pretty small part of your business. Could you give us a sense if you've been able to dissect or if you have any data around. How many incremental customers are able to capture with that platform versus what is just -- your existing customer just doing the transaction online and sort of come into the store? Any color around that would be helpful. And then just how you're expecting Acceleride to drive maybe incremental growth versus what you've done historically on both E&S going forward?

Rajat, this is Daryl again. With Acceleride, our focus has always been to make it as easy as possible for our customers to do business with us. Things that we see as our Acceleride customers close at about 50% higher rate than customers that come to us through a different avenue. So potentially, there's some incrementality because of that. The retailing -- the digital tool itself, we think, is very good and robust and easy to use. It's hard for us to put a number on how much is incremental or not. We tend to look at Acceleride as an iterative part of our business, how do we improve it a little by little so that our customers have a better and better experience, and we expect it will continue to be a bigger piece of who we are a year from today than it is today. What that line exactly looks like. I'm not sure I can tell you at this point. But we see several quarters now where it's increased.

And with that, I'd like to turn the call back over to Earl for any closing remarks.

Well, thanks, everyone, for joining us today. We look forward to updating you on our fourth quarter earnings call in February. Have a good day.

And that does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time and have a great day.