Penske Automotive Group: Despite Bottom Line Pain, Shares Look Attractively Priced (PAG)

Over the past couple of years, I have been particularly interested in a few key markets. One of these has been the automotive retail space. It is a highly fragmented industry and some of the players in it have achieved rather attractive results by means of consolidation. And because of concerns about the economy more broadly, and particularly about interest rates and inflation, many of the companies in this market have traded at low multiples. One firm that I have been fairly bullish on in this space but that has unfortunately underperformed in recent months is Penske Automotive Group (NYSE:PAG). For those not aware, the multibillion dollar firm operates 336 retail automotive franchised dealerships. The company also has a couple of other operations, including one that acts as an importer and distributor of heavy duty trucks in Australia, and another unit called Penske Transportation Solutions that holds its 28.9% ownership interest in Penske Truck Leasing Co.

Back when I wrote about the company last in July of 2023, I rated it a ‘buy’ because of how cheap shares were. I was also impressed with the strong revenue growth, stock buybacks, and consistent dividend increases implemented by management. At the time, I did acknowledge that bottom line results had shown weakness. But this was not, in my opinion, a reason to be pessimistic. Unfortunately, the market has since disagreed with me. Since publishing that article, shares of the business have seen downside of 9.4%. By comparison, the S&P 500 is up about 15%. But even with that weakness, the stock has only gotten cheaper. While the firm is not the best player in the market, I do think it offers enough upside to justify optimism from this point on. And in fact, if shares get much cheaper from here, an upgrade to something more bullish could be on the table.

Checking in on Penske Automotive Group

When I last wrote about Penske Automotive Group in July of last year, we only had data covering through the first quarter of the 2023 fiscal year. Data now extends through the end of the 2023 fiscal year. So that might be a great point to start. During the year, revenue for the company totaled $29.53 billion. That’s 6.4% above the $27.81 billion generated in 2022. Revenue during this window of time grew across all three of the company’s main sales lines. Retail automotive dealership revenue, for instance, grew from $23.69 billion to $25.21 billion. While the company did see used vehicle sales drop from $9.01 billion to $8.92 billion, and it saw finance and insurance revenue decline from $848.1 million to $838.6 million, all other parts of the sales segment reported year over year growth.

New vehicle retail sales, for instance, managed to shoot up from $10.05 billion to $11.27 billion. This was driven by a couple of different factors. While the company did benefit from some acquisitions, much of the increase seems to have come from same store retail sales. The number of units on this basis expanded from 179,703 to 191,039. Another 32,672 units came from new agency sales. In addition to seeing an increase in the number of units sold, the business also reported a rise in the average price per unit. This expanded from $54,084 to $56,857. However, because of an increase in the supply of many of the vehicles that the company sells, it did not have the same kind of pricing power that it had back in 2022. Higher financing costs also proved to be an issue during this time.

Fleet and wholesale revenue managed to grow over this time from $1.36 billion to $1.44 billion. But the most impressive increase, at least on a percentage basis, involved the service and parts category. Revenue spiked 12.7%, climbing from $2.43 billion to $2.73 billion. $220.2 million of this rise was driven by higher same store sales. Acquisitions of dealerships added $87.4 million to the company’s top line as well. Management attributed the $155.5 million increase, amounting to about 9% over all, that came from same store properties due to the fact that vehicles are remaining on the road longer as consumers look to cut their expenses.

Although not as significant, the company did see increased revenue from other areas. Retail commercial truck dealership revenue, managed to rise from $3.54 billion to $3.68 billion. New truck sales pushed revenue up from $2.31 billion to $2.48 billion. It is true that used truck sales were a weak point for the company. But they pale in comparison to the impact of new truck sales. Service and parts revenue, building off the same theme as with new retail vehicles for the masses, reported an increase from $852.2 million to $907.3 million. That’s 6.5% year over year. And lastly, the commercial vehicle distribution and other category for the company reported a sales increase of 9.5% from $578.8 million to $634 million.

With revenue rising, you might expect profits to have risen as well. But this is where some of the weakness comes in that I have been talking about. Net income actually plummeted from $1.38 billion to $1.05 billion. It’s no secret that the business did report a drop in profits per new vehicle sold. But also painful was a rather meaningful increase in selling, general, and administrative costs from $3.22 billion to $3.40 billion. Higher advertising expenses aimed at attracting greater revenue was partially responsible for this. A 17% increase in ‘other’ expenses also negatively affected the company. Add on top of this a reduction in equity in earnings of affiliates from $494.2 million to $293.7 million, as well as a rise in interest expense from $122.8 million to $225.7 million, and we get some rather meaningful changes.

Even with these pain points, shares of Penske Automotive Group are attractively priced. In the chart above, you can see how the stock is priced using results from both 2022 and 2023. I then compared the company to five similar firms as shown in the table below. While on a price to earnings basis, the stock is pretty pricey, with four of the five firms being cheaper than it, it’s actually the cheapest of the group on a price to operating cash flow basis and it’s the second cheapest on an EV to EBITDA basis.

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In addition to being cheap, Penske Automotive Group has a long history of rewarding shareholders directly. From 2018 through 2023, for instance, the firm allocated $806 million toward dividends. It also allocated $1.85 billion toward share repurchases. Along the way, the company made sure not to neglect its growth opportunities and its existing operations.

Capital expenditures, for instance, have totaled $1.64 billion over the last six years, while the amount allocated for acquisitions over the same window of time totaled $1.68 billion. Although management has allowed leverage to increase slightly from its low point in 2021 and 2022, the firm has still managed to decrease its leverage ratio from 2.9 back in 2019 to only 1 by the end of the 2023 fiscal year.

Takeaway

The way I see it, the automotive retail space is a very interesting segment of the market to play in. It almost doesn’t matter which vehicles end up winning at the end of the day. Regardless of who wins and who loses, there’s an opportunity for those in the automotive retail market to thrive. Management at Penske Automotive Group has taken advantage of this opportunity to buy up a number of other firms over the years. They have also pushed for organic growth. Along the way, the company has bought back stock, paid out dividends, and its shares are trading at low levels on both an absolute basis and relative to similar firms. If the stock falls much further, I could see myself upgrading the business to a ‘strong buy’. But for now, I feel as though the ‘buy’ rating I assigned the business still makes sense.