Penske Notes
 

Bullet points from Penske visit 1/21/13

 

1.    Penske Auto Group is a 13 year old company with a management team that has a 40 year track record in automobile dealership operations.

 

2.    PAG is entering the second phase of long term operation, as the first phase of development, data management, core markets and operational matrix has been established.

 

3.    Second phase will be expansion of markets and dealer footprint (including globally), transition to younger management, expansion of equity.

 

4.    Gross margins will be improved by continued refinancing of debt, purchase of non-producing real estate leases, operational efficiency, and additional acquisitions.

 
 

Penske Auto Group was established in 1999 and has grown to over 390 dealerships in the US and Europe. The company’s ability to obtain financing over the early stages of acquisitions has enabled PAG to purchase and then remodel locally owned dealerships from family owned to corporate owned. This process of streamlining operations using operational hubs and decades old primary business practices has allowed PAG to gain the confidence of sellers and manufacturers, and allowed the company to develop their current dealership footprint.

 

Senior management has guided PAG through this initial growth phase at a very rapid pace while laying the foundation for a long term industry leading company. The experience of senior management in daily operations, finance, manufacturers’ relations, personnel, data consolidation and plain intuition regarding the automobile distribution business cannot be replicated. Therefore the first phase of the company’s evolution must begin its transition into the Second phase of long term operations.

 
 
 
 
Second Phase
 

Market and footprint expansion will be key to PAG’s continued growth. The current footprint is solid, yet gaps on the US map are obvious. The Southeast is the most apparent and will allow the greatest long term growth. Currently, there is considerable competition for this part of the nation, yet PAG must be an active bidder for campus style dealerships in markets like Nashville, Atlanta, Charlotte, Raleigh, Charleston, Columbia, Birmingham, Savannah, Richmond, possibly Florida and extended operations around Washington D.C.

 

Additionally, PAG has a unique opportunity to expand in Europe, South America and in the oil producing nations as the manufacturers will look favorably on PAG as a healthy transcontinental operator. The next management team for PAG must be conditioned to develop these markets in order for PAG to grow with their current high end profile and product mix. That management team may be developed from organic selection via seasoned PAG dealership managers, current upper level corporate managers, and pulling from younger, yet seasoned executives from manufacturers with foreign experience.

 

The culture of PAG is very professional and will attract high quality recruits to future management. It is important that senior management and the Board of Directors begin the process of a long term plan that includes footprint growth alongside management recruiting that prepares the company for doubling in size.

 

With almost 15,000 automobile dealerships still in existence today, the forecast for the next 20 years will be fewer dealerships, not more. As manufacturers grapple with how to reduce the distribution element of their business, corporate ownership will become more appealing. The startup costs for an individual to open a dealership is prohibitive, and manufacturers are becoming more aware that a shorter build schedule, desire to have minimal inventory, and desire to control pricing and maintain a consistent marketing effort requires professional dealers. PAG has led the way establishing a template for corporate ownership and has proven to the manufacturers that corporate ownership has tremendous advantages over family ownership.

 
 
 
Gross Margins
 

The stability of gross margin in the low 15% range is a testimony to excellent inventory, pricing, resale and overall operational control. Senior management admittedly wants margin to approach 20% and is looking for ways to expand gross margin. Refinancing of debt is an intentional and opportunistic tool that the company is using well. Current lending rates are favorable and PAG has done several refis that will lower interest expense over the next three years.

 

Additionally the company needs to review and buy down nonproductive real estate leases that will be long term addition to margin. Because most of these leases are private transactions, it is difficult to forecast just how much renegotiating these leases will impair short term earnings.

 

PAG’s gross margin will be most impacted by acquisitions. Under the current management and operational framework, it is our opinion that PAG can increase their dealer footprint domestically by approximately 25% with little or no addition to management or operations. Finding multiple branded dealerships from tightly held owner operators and families should provide PAG with many acquisition opportunities over the next decade.

 

Specifically, gross margin can also be impacted by additional sales training regarding F&I at the dealership level, continued Internet consistency across the dealership platform, lube bay and collision and repair facility expansion.

 
Stock Price Performance
 

The attached weekly chart reflects the price movement of PAG for the past four years. The recovery of equity reflects management’s commitment to continued acquisition, refinancing of the debt, auto financing available to the buyers, the return of auto leasing and as importantly the company’s effort to tell the “Penske story” to analysts and asset managers.

 
 

Prior to 2012, PAG seemed reluctant to push information to the investment community about the details of how the company worked and planned for the future. This probably was a result of company culture. The company has stood on results much more so than expectations and has maintained a cool, not over solicitous, yet cordial approach to Wall St. The small amount of publically traded stock as a percentage of total equity may have led Wall St. to take notice of PAG, but may have discouraged participating in the stock widely. 

 

This seems to have changed in the last 12 months and can help explain the increased monthly volume and higher support levels as new owners enter the stock. Noticeably, the PE expansion has also brought PAG closer to their peer group, although some of these new owners may not be long term holders if the automotive group comes under selling pressure in 2013. Interestingly, monthly volume has slowed as the PE multiple crossed above 15.5. 

 

PAG has successfully completed its development from a private company into a public company with the ability to now mature into a long term sustainable entity. This company will be able to expand due to access to capital, access to a shrinking dealership network, a track record of professional best practices, and a desire from senior management to pass the company to other seasoned professionals through equity ownership expansion.   

 
Matthew C. Burril