Penske Automotive Group Inc (PAG) 2016 Q2 法說會逐字稿

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's 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, Investor Relations and Corporate Development. Please go ahead.

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 are Roger Penske, our Chairman; J.D. Carlson, 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 and factors that could cause results to differ materially.

I will now turn the call over to Roger Penske.

Thank you, Tony. Good afternoon, everyone, and thank you for joining us today.

I'm 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. If you 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 the Harper Truck Centres, 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 10-year subordinated notes at 5.5%. We used the net proceeds from this offering to repay amounts outstanding under the Company's US 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 the automotive retail space.

I am also very pleased to announce today that we've 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 on earnings accretion on an annualized basis and also provide significant cash tax savings, which we believe will be heavily weighted to the first two years of our investment. Within those first two years, we estimate the cash-on-cash return to be between 30% and 35% of 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 is generated through our retail automotive dealerships.

If you look at the mix, our international business has now climbed to six -- 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 nonautomotive joint venture investments.

Let's turn to Q2 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 big three. On a same-store basis, the variable gross profit per unit -- that's gross profit from new vehicles, used vehicles, and F&I -- was $3,613, 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 $3,106 and gross margin improved 30 basis points to 7.8%. Gross profit increased $118 per unit, sequentially. Excluding foreign exchange, gross profit per unit retail was $3,175, an increase of $169 per unit. When you look at our days 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 US. Our used to new ratio was 0.85 to 1. Our used vehicle revenue increased 6.9% to $1.5 billion. Gross profit per unit -- used unit retailed was $1,697, down $85 per unit. However, on a sequential basis, gross profit per used 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 $1,736, down $47 per unit.

Our supply of used vehicles was 43 days at the end of June. Finance and insurance revenue per unit was $1,092, down $32 per unit. Excluding foreign exchange, F&I revenue per unit was $1,118, down $6. On a same-store basis, excluding foreign exchange, F&I revenue increased $69 to $1,194. 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 is 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% to just over 2,200 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 at 37%, but our fixed-cost absorption ratio was 117% in the quarter.

Looking at our balance sheet, we had $98 million in 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 at 5.5% in May 2016. We used the proceeds to repay amounts outstanding on our US revolver and floor plan debt. As of June 30, we had over $700 million of 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 down -- up $8 million.

Approximately $57 million of our US inventory is currently on OEM stop sale, representing approximately 2,600 vehicles -- new vehicles value of $22 million, approximately 400 units, and 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 a lease buyout, which we replaced with a mortgage.

Before opening the call for questions, I wanted to address the referendum or Brexit vote held in the UK. Obviously, I have had a lot of questions regarding the effect of this vote on our business. While this is an unprecedented event, we remain positive and encouraged about our business in the UK and throughout Europe. We have a 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 denominated in British pounds, so we have a natural hedge. Our exposure essentially is limited to translation of UK results into US dollars. There is no transaction risk.

UK light vehicle sales are over 50% Company cars. These are vehicles that are typically on a three-year personal contract purchase, which is very similar to a lease and provide replacement demand as the lease expires. The remaining 50% of the new vehicle market are predominantly retail sales to private individuals.

Also, the UK is a net importer and a very important market within Europe. We believe the remaining EU countries will look to negotiate favorable trade deals with 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, our new vehicle orders are up 3%. Our used vehicle orders are up 5%. Based on our full-year results in 2015, if we just translated the UK results into US dollars in [215] 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, so 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.

(Operator Instructions). John Murphy, Bank of America Merrill Lynch.

Just first question, a follow-up on Brexit. Obviously, it sounds like some of the early signs post vote or referendum are reasonably constructive relative to some of the fears in the market. I was just wondering if you could highlight any periods in time you could remember where you had disruptions. Obviously, this is a bit unprecedented, but any other disruptions in markets where your retail customer, given your brand mix focused on high-line 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 a little bit over there, will your customers show up more.

I really -- I can't just offhand 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's been growing up from roughly 17% to 25%. So the units 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 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 than maybe 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 because people would run those cars until leases were up.

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

Okay, that's 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 that were putting pressure on gross profit per unit on the new side seem to have eased. 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 talk to them and say, hey, we got enough inventory right now, we need to work through what we got, and that they are acting a little bit more rationally and there is a more rational environment among your competition, particularly on the luxury side?

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 US, we got 71 days, internationally we got 57 days, for a total of 66, and yet on a same-store basis our inventory is down almost $190 million.

And I think that most of the mix shift, obviously, is we've 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've 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 at what they supply here to the end of the year. But I think they're being rational. I think initially, because China slowed down, they had more inventory and they thought they would really dump it here in the US. But I think the 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% will be trucks or SUVs.

So, we have to learn how to manage through that, and I think that at 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's really not a problem that I am focusing on.

Okay, and then can you just talk about -- a little bit about the tax benefits from the PTL acquisition? And really, I think you talked about it being in the first couple of years. But just curious how long those benefits could last, and if you could just maybe dimension them as best -- I know it's tough to calc, but dimension them as best you can for us as far as size and duration of those benefits.

Number one, we have to have profits in the US in order to be able to take advantage of the tax benefit. And typically under the revenue code, you can go back two years and you can go forward for 20, so whatever benefits we get from the accelerated depreciation and bonus depreciation that you have with our truck leasing investment will stay with us through a long period.

I think I said on the call that we are looking -- if you guided 30% or 35% cash-on-cash benefit of $500 million, you can do the math yourselves. We see that in the short term, probably over the next 12 to 18 months max, so it is very strong for us.

That's incredibly helpful. And then just lastly, it sounds like if you looked at the stop sale vehicles, it is about 2,600, 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 in big quantities, you get these cars fixed so you have a big -- you have may be a material step-up in warranty work, and then you also get this bump from these used vehicle sales finally get out there in the market? Is that something that could happen in the third or fourth quarter if you get all these airbags in?

Well, look, number one, it is not a big number of ours. I think as we do these, it is not too complex, and what we have to do is we've got to focus on customer cars and then we would focus on cars in inventory. And I see these, they are 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 downward impact on our used car business, at least in BMW here over maybe the last 60 days, but I see that flowing out.

The only risk that I think we have is that if everybody decides to wholesale these cars into the market, instead of retailing, there might be some residual, probably, or value deterioration going forward. But we are certainly looking at, with our 0.85 to 1 used to new, and when you look 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.

Great. Thank you very much.

Rick Nelson, Stephens.

Roger, a question actually about the dividend. We have seen a $0.01 increase I think going back 21 quarters, $0.01 each quarter. You've got a 3% dividend yield today. What sort of payout ratio are you targeting?

Right now, our payout is about 25% and I think I have said in previous discussions that we would try to get to 30% to 35%. I think that the shareholders that I talk to and certainly the ones I represent like dividends. So, I think that's realistic.

Great, 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?

I can tell you it is certainly on our Board to take a look at. But we have got to be sure that our balance sheet is safe and secure and we're going to be an opportunistic buyer there.

There is no question about it that if we can generate the cash flow we expect from earnings, and then with the tax savings, yes, 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 there is now 15% left and we feel that it would be a great additional asset to own by PAG.

Nobody knows it better than you guys, but thanks very much.

James Albertine, Consumer Edge Research.

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

I think that with the ability to provide in the premium luxury side the service customer with a loaner car, we have really ramped up our loaner car fleet to several thousand, and management is determined that these are very good cars if you got them out with low mileage. So, what we have tried to do is accelerate that and try to have cars that are anywhere from 3,000 to 4,000 miles max and pull those out.

And these are not cars we can't sell and we just put them into loaner. These are good cars that are -- we know that will come out and have good value, because we depreciate them roughly, say, 1.5% to 2.5% per month. We put them in at net. We bring those cars out, then we are able to apply the new car programs to those with the different manufacturers and they become a very good car to move a customer that maybe doesn't want to reach for a new car, but will buy one of these young used cars at a lower payment if is a lease or even a transaction 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 that to be our offense to the end of the year.

So, with the OEMs wanting us to take more of these vehicles, it gives us the opportunity to be able to put them into loaner, and I think that these lease returns also that we will get. Give you an example in BMW of 10,000 coming back just in 2016. So this is the fuel that runs the engine for us on the used car side, and that's what I said earlier here. Just in BMW, we are over 1 to 1, used to new, so I think these programs and this young used is almost like another channel for us.

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

I think at some point I might be cannibalizing a little bit of 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's a lease, I'm going to get that opportunity to get that car back in 24 or 36 months.

So, I think it is really important to do that. And obviously with the Internet, we can put these cars on the Internet, and also with penskecars.com, we're getting a lot of traffic there, which really, really will help us. Our digital marketing has really moved up. Mobile growth, in fact, if I went back and looked at 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.

Excellent. I 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?

The strongest quarters 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 or they go back, so we do about 600,000 one-way rentals and a big portion of that is done in the middle of the year.

We get a little bit of a spike in rental at the end of the year when FedEx and UPS take 4,000 or 5,000 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's what 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 it is logistics, and we continue to grow that, and that really grows on the basis of [maybe these are] automotive accounts, but other types of industries. And we see that starting to flatten out in our earnings across the 12 months.

Got it. Thank you again and best of luck in the next quarter.

Brian Sponheimer, Gabelli.

I guess my question would be on regional differences during the quarter, particularly in the Northeast as we headed into Brexit. Any changes there?

I would say that if I looked at the business in the US as 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. And that had been down. I think I mentioned in previous calls that we had had a little bit of pressure in the Northeast, and northern California is strong.

In Texas, I have heard a lot of conversations about Texas, and our truck business, heavy truck business in west Texas, in Midland, Odessa, and Amarillo, obviously we have seen an impact there on new trucks. Service and parts continues to be good, but when we look at our auto business in Texas, really we're talking about two Honda stores in Houston, then, of course, the 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.

Okay, that's helpful. And then, you mentioned warranty. Can you remind us? There was a BMW issue last year on the warranty side that may have caused a difficult comp for this year?

Yes, when you 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 and internationally, but we get less margin on warranty in the UK because we get a very small markup on parts.

On the other hand, in the US our warranty was down, and normally warranty has a better return both on the labor side and the parts side than we have on customer labor. So, there was [Vanhos] at BMW, an engine retail overhaul that we had for BMW, which 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 us probably 100 to 150 basis points.

Okay, thank you very much. Nice quarter.

Paresh Jain, Morgan Stanley.

A couple of questions. So earlier today, we had one of your peers talk about how they could get a lot more aggressive with acquisitions if SAAR declined 10% to 15% from here. Do you share that view and do you see something similar happening at Penske if that were to happen?

I think there is a number of people out there testing the market that probably are interested in selling their business. But right now, as I think has been reported even by our peers, some of the expectations just don't make any sense from the standpoint of being able to have growth, even if you can come in and take cost out, because a lot of this business as we look at it has 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're 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, having to stand still.

But we see a lot of activity in Europe and that's 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 up. And those are areas that we are very active in 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 would look to continue to grow our heavy-duty truck sales business.

So, overall, I think it is individually what you want. We are premium luxury, so it is tougher and tougher to find those deals at reasonable prices here in the US where there might be others that might be available. So I think -- depending on what your mix is, I think we all have strong balance sheets that we can make those, but we sat back at the beginning of the quarter and 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 Leasing. We looked on the cash-on-cash return; we looked at the company, no people, no CapEx, no vehicles, and if we could get this kind of return in a business we already own a piece of, it was the way to go. So, we would look at that to be a priority for us maybe in the next 12 months.

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 take 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?

That would be right, yes.

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

I think when you look at the business, we have core competency in transportation services, don't we, from the standpoint of being in the truck business. We built Penske Truck Leasing over the last 25 years. It builds on our relationship with Daimler and Freightliner, and I think as we look into our logistics business on a longer-term basis, we can build on our OEM relationships from the standpoint of our 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 billion 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 has pretty much been consistent where you have two years back and 20 years, I think, forward that you can utilize these tax benefits. But we get the benefit of purchasing tires, fuel, oil, many of our abilities as we look at our buildings from a standpoint of insurance. There is a number of things that we can do together, and when we go out to bid 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's no question that we are expanding in Australia. PTL has expanded in Australia with us on the truck and distribution side.

That's great color. Thank you.

Bill Armstrong, CL King & Associates.

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 flesh out how you were able to generate that kind of increase.

I think that we focused on conquest accounts in our area of responsibility, and quite honestly, as you know, we bought that business in Tennessee, in Chattanooga, in Knoxville, and part of Georgia, and we were able to conquest Covenant and US Xpress, 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's just putting our management team together, our knowledge. Rich Shearing 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 fleets 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 is an expert in service process, which is hoping to take our downtime for truckers to a very low level to give us better Net Promoter Score in 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 Detroit Diesel, so a lot of these customers I was calling on myself door to door to get business years ago and I'm back doing the same thing, which certainly I think in conjunction with the team at certainly the Freightliner business, Premier, has made a difference.

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 topline, the strong truck sales. What is going on there and is there any cause for concern or were there any unusual events going on?

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

Okay, thank you.

David Lim, Wells Fargo Securities.

With all this whole Brexit situation and then discussions about US sales, et cetera, can you dive in into your flexible variable-cost structure? How quickly can you guys flex down? Would you be able to flex down within a month or is it a one- or two-quarter thing? If you could dimension that, that would be very helpful.

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. And that represents, in the total market, about 750,000 vehicles. And we are running about 9% of that, so to me, I think that we are looking probably at about, in our case, 6,000 or 7,000 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. We had inventory reduction. But I mentioned earlier on the call, our units in operation have grown substantially because I think, Tony, if I'm right, since 2008 the premium luxury has grown from about 17% of the market to this 25% or 26%. So, we will get the benefit of the parts and service.

And remember, from a PAG perspective, only 9% of our revenue comes from parts and service, and I think that this will give us the chance as 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, it will help us drive through if there would be an issue. Used vehicles also is an offset, and remember in the UK, we're over 1 to 1 new to used, used to new.

Great, that's very helpful. The other question I have is what is your thought, Roger, on the US sales outlook? We have been averaging, I think, 17.1, 17.2 for the first part of the year. Any preliminary or any thoughts 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 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?

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. We have seen fluctuations there, and then we have got such a used car opportunity there if the new cars are down. So, look, I think 17 million, if we could have 17 million throughout the year, I think that's 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 incentives are up 12%, I think, for the month versus last year. That just costs them money.

So I think that they will be rational on inventories, as I think that's 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 there might be something wrong with them. It is interesting how we are trying 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 72 hours. I think you will be able to communicate -- I think all the public companies and many of the private guys are pretty smart here. They're going to have tools that you can either through the Internet, through their capability with the Net, you're 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 or 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, but typically pool stock wouldn't have the specifics of what you might want to custom order. It is probably like getting a custom suit versus one that you buy off the shelf.

And I think that -- I think we are build to order in, you said, 72 hours, I think it was, would be pretty difficult. But it is certainly a way to go, but I think we're in this with Walmart and with these big discount places, people want inventory. They want to -- they're impulse buyers in the auto side and I think we'd sell less and less unless it is a Porsche 911 Turbo or a Bentley or something like that that 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 and there you can't really spec the car.

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

Brett Hoselton, KeyBanc.

I think I want to talk 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, US, Europe, and then, also, it seems as though there may be an opportunity down in Australia. I think you talked about that longer term. Where is your thinking out there?

Let me say this. Australia right now, I think we're really looking at taking cost out in our truck distribution because, ironically, the average heavy truck here is 6 years old. It is almost 12 years old in Australia/New Zealand and we are seeing the market still going down, so I don't think we're going to be making a lot of acquisition specifically in the truck market.

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 and 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. We made an acquisition of 11 stores here, the Lighthouse Group here, in the last couple of months here.

So, we see that continuing to be maybe our fishing area. The US 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 a little higher to get something like that.

But I would say in order it would be western Europe. Today, continue in the UK, watching the premium luxury in the US, 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 and 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're going to be very opportunistic with our capital. Then, of course, we have this additional 15% that we have to take a look at on a longer-term basis from GE on PTL.

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 US dollar, et cetera, et cetera, et cetera.

So it doesn't seem as though FX is necessarily -- 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 US where the 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 sit back and I look at the Brexit situation and I'm wondering how that might be different, and I am 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?

It is interesting. I used the same example to people here in the last couple days about Toyota and Honda. The yen has been all over the map with the US dollar and they haven't 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 that 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 are going to 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 the most important thing you and I should do or we should do is -- certainly group 1, the people are involved in this, is really take a pause here. August is not a good month to look at because it is pre-registration, which comes in September, and we should wait and see what happens into 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.

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

Mike Montani, Evercore ISI.

I just wanted to flesh 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?

We have -- when you look at overall for PAG, and this is domestically, internationally we really have very little, we have about 2,200 used cars, which is about 12% of our used car stock, and we have about 400 to 500 new, so -- and we are managing through this.

I think that I said earlier on the call that it will probably take us probably 60 to 90 days to work it through. We 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 million new and $35 million used. We think we can complete -- the recall here before the end of the year, obviously, and I think we're halfway through the BMW.

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 --

I hope it is before then because they have been very good at supplying us support from depreciation, et cetera, et cetera, and I think you're going to see that sunset here shortly. And they're 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 airbag issues. We will do those first. Then, of course, we would do our own cars in inventory.

The only one thing, I stated earlier, was that if everybody decides once they get the parts, the retailers decided to wholesale, these cars, then it could hurt the value in the market, but in our case we're going to retail them because there is some good cars for us from the standpoint of opportunity from a used car supply perspective.

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?

I would like to see our used car business, plus not -- 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 are so strong on used cars. But I -- if a customer wants to buy -- look, trust me, if someone comes in and wants to buy a car and we have it in inventory, we're going to try to put him in something else. That would be certainly my direction to the sales managers and sales force we have in place.

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 US and UK.

Today, we get 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 our new, our used, and our F&I, we're up, I think, $43 across the business. And I think that to me is what we are watching.

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

That's helpful. Thank you.

Pat Archambault, Goldman Sachs.

Actually, it is Dave on for Pat. And I know it has been a long call, a lot of great detail. Just one question on the 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 holding up used values and residual values or are you not seeing that?

I would be the wrong guy to ask that. I'm trying to be close to my business, but I can't tell you. Particularly in the market, I think it changes every day.

But right now, we have 10,000 BMWs that will come back during 2016, and when you think about that, that is 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 sold almost 11,000 used cars, so you can think about that. A big portion of those are ones that are coming back off of lease. Now 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, et cetera.

Okay, I will ask the other dealers then. Thanks, Roger.

David Whiston, Morningstar.

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 in the UK consumer is? In other words, are there mix 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 get downgraded to a volume brand?

That could be if someone has a concern. But we haven't seen that. I think we really have to look out the registration market because, as you know, that market, most people's compensation, 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, put people in a lower-priced capitalized cost on a particular lease. But we haven't seen that at this particular time.

I really think it's too early, and with the different opportunities in lease and PCP over there, I don't think that's 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 dropped some of that business to the other OEMs and we saw that directly in the US -- excuse me, in the UK.

Okay, thank you. And on the PTL accounting with the increase in that stake, the $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?

It's equity. What we'll do is -- it is equity income. It is just the cash, you get the benefit of the cash that you generate from the tax benefits, the carryover from the depreciation on the taxes. 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.

Okay, thanks so much.

Carl Dorf, Dorf Asset Management.

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 you have with that? And I definitely do like the increase in the dividend. I don't necessarily want you to stop that, [can only get to] always 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?

Let me start with Australia. I think the benefit is that we had a truck distribution business that in 2014 was strong. We saw that deteriorate, then 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 said earlier we want to go 30% to 35% payout, so as the business earns money, I would hope that the Board would continue to approve a 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, it 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 by -- 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, along with our acquisitions and dividends, becomes the only thing that we have to manage carefully.

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

Correct.

Okay, thank you very much, Roger.

Carl, if you look at -- 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 can buy one dealership or two dealerships or three dealerships and it would take you a year to consolidate those. With 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 in that business. And you look today, you look at Ryder and you look at PTL, you can see our numbers through zero in our bonds. It's a very good business. And quite honestly, the multiples in the truck -- excuse me, in the truck leasing and logistics business are better than ours, so maybe that will help our stock.

Thank you.

Douglas Karson, Bank of America Merrill Lynch.

Thanks for hosting the call with all the detail. I have one 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 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 looking for maybe timing on (multiple speakers)

When you looked at the -- 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 US, cash on our balance sheet, and we had a significant paydown of our floor plan. So when you rolled it all together, I think, like 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 and we had all the room in the world to do that with the manufacturers.

Right, okay. That makes sense. Thank you for that extra color and (multiple speakers)

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

All right, thanks for joining us today. We will look forward to getting together after our September results. Have a good day. Thanks.

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