AutoNation (NYSE: AN) - Q4 2023 Earnings Call

Welcome to the AutoNation incorporation fourth quarter 2023 earnings conference call. My name is Bruno, I'll be operating your call today. During this presentation, you can register to ask a question by pressing star followed by one on your telephone keypad. I'll now hand over to your host, Derek cig, vice president of investor relations. Please go ahead.

Thank you, Bruno, and good morning everyone. Welcome to AutoNation's fourth quarter 2023 conference call. Leading our call today will be Mike Manley, our Chief Executive Officer, and Tom sodic, our Chief Financial Officer. Following their remarks, we'll open up the call for questions. Before we begin, I'd like to remind you that certain statements and information on this call, including any statements regarding our anticipated financial results and objectives, constitute forward-looking statements within the meaning of the federal private securities litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks that may cause our actual results or performance to differ materially from such forward-looking statements. Additional discussions of factors that could cause our actual results to differ materially are contained in our press release issued today and in our filings with the SEC. Certain non-GAAP financial measures as defined under SEC rules will be discussed on this call. Reconciliations are provided in our materials and on our website at investors.autonation.com. With that, I'll turn the call over to Mike.

Thank you. Okay, perfect. Thanks Mike. I'm turning to slide four to comment on our fourth quarter P&L. Total revenue increased slightly as growth in new vehicle and after-sales revenue more than offset lower used vehicle revenue. As expected, gross profit was down 5% and margin was 18% for the quarter. Strong growth in after-sales partially offset declines for new and used vehicles, which I'll address in later slides. Adjusted SG&A increased 5% to $791 million, with stable core spending and incremental costs related to our growth initiatives. This resulted in adjusted operating income of $368 million for the quarter, which decreased 22% from a year ago. Below the operating line, our fourth quarter results were impacted by higher interest expense for both floor plan and non-vehicle debt, and benefited from lower income tax expense. The fourth quarter floor plan interest expense of $47 million was up from $20 million a year ago, a reflection of higher rates and inventory levels as expected. As a reminder, we reflect floor plan assistance received from OEMs in gross margin, and in the fourth quarter, the increased assistance helped to partially offset the increase in floor plan interest expense. Interest expense from non-vehicle debt was $46 million for the quarter, up from $38 million a year ago. The increase reflects increased borrowing and higher rates. Income tax expense for the quarter was $62 million compared to $91 million in 2022, reflecting lower taxable income and a modestly lower income tax rate. All in, this resulted in adjusted net income of $216 million compared to adjusted net income of $319 million a year ago. The impact of our share repurchase activity partially offset the EPS effect of the lower net income. Total shares repurchased over the year decreased our average shares outstanding by 14% to 42.9 million shares in the fourth quarter. Our adjusted EPS was $5.2 for the quarter. Starting with slide five, I'd like to build on the color Mike gave on the performance in our various revenue categories for the quarter. New vehicle volumes were up 8%, which includes increases of 16% on imports, 3% on premium luxury, and flat domestic units. New vehicle gross profit PVRs continued to moderate while selling prices were stable; vehicle costs were higher. The rate of decline for the fourth quarter in gross profit PVR was about $375 per unit, which slowed from the approximately $600 per unit sequential decline in recent quarters. This reflected the higher seasonal premium luxury mix and a more stable, although still less than ideal, environment for battery electric vehicles. New vehicle inventory levels, including vehicles in transit, have increased from 18,100 units in 2022 to 35,300 units at the end of 2023. Moving on to slide six, in used vehicles, we had a unit volume decline of 4% from a year ago, as Mike mentioned, on a total store basis and 8% on a same-store basis. There continues to be a shift to lower-priced used vehicles. Our same-store unit sales of used vehicles priced under $20,000 increased 7%, while used vehicles over $40,000 increased 20%, and used vehicles priced from $20,000 to $40,000 were down 11%. From a segment standpoint, used unit volume performance was strongest in our import brands. Year-over-year unit sales and gross profit PVRs in used vehicles were adversely impacted by the pricing band mix I mentioned and reflect an overall softer used car pricing environment. Used vehicle inventory levels increased sequentially and year-over-year, reflecting our stepped-up buying activity in anticipation of the customary spike in first quarter used car volumes. As Mike mentioned, we expect our first quarter PVRs to be at or slightly below fourth quarter levels, reflecting a conscious effort to align inventory levels and turn rate with the market. Used PVR improvement is expected late in the first quarter as the fourth quarter inventory is fully turned. Used vehicle sales and profitability continue to be a big area of focus for us as we emphasize effective sourcing, pricing, and speed while optimizing customer satisfaction. I'm now on slide seven. In customer financial services, our industry-leading performance continued. As you can see, gross profit PVR for CFS remained strong and would have been even stronger absent the shifting of economics related to AutoNation Finance lending. The upfront fee previously received from non-recourse third-party lenders is now deferred over the life of the AutoNation Finance loan. New vehicle product attachment and finance penetration in CFS remain strong and increased from a year ago. We have seen an increase in leasing, which represents 23% of new sales in the fourth quarter compared to 13% last year. This is a minor headwind for CFS PVR as leased vehicles historically have a lower CFS attachment rate. On used vehicles, there were slight decreases from a year ago on both the finance and product side of CFS as higher interest rates consumed more of our customers' monthly payment capacity. As Mike mentioned, in addition to fully supporting all USA stores, we now have AutoNation Finance present in nearly all franchise stores. In the fourth quarter, we originated approximately $110 million in loans, up from $63 million in the third quarter. The AutoNation Finance business continues to improve in all dimensions, including penetration in our stores, profitability, and delinquency rate. Let's move to slide eight. After-sales represents about 44% of our total gross profit for the quarter and continues to grow, with total store revenue increasing 11% to $1.1 billion, or 9% on a same-store basis. Customer pay, warranty, and internal all experienced double-digit year-over-year growth. The value per order is improving, and our total number of repair orders has also increased. Gross profit grew 13% year-over-year on a total store basis and 12% on a same-store basis. Total gross profit was up double digits for customer pay, warranty, and internal, and our gross profit margins were up more than 70 basis points to 47%, reflecting higher repair orders, higher value repair orders, and scale benefits from the increase in the number of repair orders. For the full year, our after-sales gross profit was more than $2.1 billion, which is up more than $500 million from 2019. This high-margin business is a key part of our continued engagement with our customers, and we're focused on capacity utilization and technician development to support the continued growth of the business. Importantly, our total technician workforce increased 6% from a year ago on a same-store basis and 11% in total. Moving to slide nine, our adjusted operating income was 5.4% for the quarter, down from last year but up more than 150 basis points from pre-pandemic levels. The decrease from 2022 mostly reflects the moderation in new vehicle unit profitability, which was expected and is consistent with the industry, as well as higher SG&A. The growth in SG&A reflects investments for growth, increased advertising spend, and inflation. Normalized SG&A as a percentage of gross profit is expected to remain lower than pre-pandemic levels. During the fourth quarter, we recognized about $7 million of severance expenses as we streamlined our regional field team and rationalized some support functions. On slide 10, you can see that our adjusted free cash flow for the year was $969 million compared to $1.5 billion a year ago. The change year-over-year is consistent with our change in EBITDA. A reconciliation for adjusted free cash flow is included in the appendix of this presentation. Year-over-year, our total inventory increased by approximately $1 billion, which was largely funded by higher trade floor plan financing and non-trade floor plan financing, which increased $424 million from a year ago. As we expect the continued normalization of new levels, we are focused on the velocity with which we turn our overall vehicle inventory. Consistent with the expansion of AutoNation Finance, our net auto loans receivable increased by $230 million, and we expect continued growth in this portfolio. CapEx for the full year was $410 million compared to $329 million a year ago, reflecting primarily capacity growth at franchise stores, IT spending, and facility portfolio infrastructure. This resulted in adjusted free cash flow of $969 million and a strong conversion of 94% of our adjusted net income. Slide 11 shows our capital allocation for the years 2022 and 2023. In 2023, we had a balanced mix of reinvestments and return to shareholders. CapEx of $410 million was about $80 million higher than 2022. As I mentioned, M&A and investments, which occurred earlier in the year, totaled $271 million. With significant cash flow generation and a strong balance sheet, we returned $864 million to shareholders via share repurchases, reducing our shares outstanding by 13.3%. We have an additional $320 million remaining under our current board authorization for share repurchases. At quarter end, our leverage was 2.19 times EBITDA, at the lower end of our two to three times target, and we continue to maintain our investment grade credit rating. Moving forward, we'll continue to allocate capital to maximize shareholder value, considering both near-term market conditions, the M&A landscape particularly for core franchise operations, and the long-term direction of the industry. Now I'll turn the call back over to Mike to provide some commentary regarding 2024.

Yeah, Bruno, if you could please remind the audience how to get in queue for question and answer, please.

Sure. Ladies and gentlemen, if you'd like to ask a question, please press star one on your telephone keypad. That's star one on your telephone keypad. To withdraw the question, press star followed by two. And please do also remember to unmute your microphone when it's your turn to speak.

Okay, we do have our first question registered. It comes from John Murphy from Bank of America. John, your line's now open.

Good morning, guys. Just wanted to ask a first question, Mike, on after-sales. It's obviously a bright spot. It seems like the efforts there to hire techs is really paying off. You keep talking about share of wallet increasing. This seems like the area where share of wallet for the consumers has the most opportunity, other than getting to the second and third turn of the used vehicle. So as you think about this in 2024, maybe even beyond, from a strategic standpoint, what do you think you need to do to continue to drive that significantly higher? Is it just a function of hiring more techs? Is it increasing connectivity? Is it getting involved in the second and third used vehicle turn? What's the key strategy there, and what are the opportunities to drive that faster or farther?

Okay, the tough one there. Just a second question on the used car business. Obviously, GPUs are down. Sounds like there's a little bit of mix going on, also a little bit of inventory management. Is this the kind of thing that you think is really a function of the next couple of quarters and then you get back to the normal GPUs, or is there something happening here cyclically or secularly that would keep these numbers low?

So Mike, when you get the turn of the ear back, being efficient, would it be fair to say that that $1,800 range on PVR is something that we should think about sort of mid to long term as we get through the course of this year and beyond?

Great, right. Thank you very much.

Thanks. Our next question comes from Daniel Embro from Steven Zink. Daniel, you may proceed with your question.

Hey, good morning everybody. Thanks for taking our questions. Mike, I wanted to start maybe on the new GPU side. Obviously, a little bit lighter moderation. Your commentary suggested that's going to continue into 2024. Curious if you can just update us how the OEM conversations are going. Are you seeing any change in tone, especially at some of the brands where inventory maybe has built? And then I'm curious, given your experience on the OEM side, what leverage do you think they have? Do you see them cut MSRP? How do you think they navigate through some of the heavier inventory situations out there?

Got it. That's helpful. And then maybe Tom, on the finance side, I think Mike and you both mentioned you've rolled out AutoNation Finance into all the franchise stores. Curious if you could provide some stats around the loan growth in the quarter, maybe the reserve or provision for losses, and then how those loans are performing as we think about the change in consumer credit backdrop today.

Thanks for the question, Daniel. As everybody knows, we bought AutoNation Finance in October 2022. It started out entirely as a third-party lender, mostly to subprime. Over the course of the last year, we've completely converted that to now supporting AutoNation exclusively, both USA stores as well as the franchise stores. Very little in terms of subprime, so it's really gone through a nice transition. We love the platform, we love the team. The trends have been very strong. We've got an improvement in the origination mix. With all AutoNation customers, FICO scores have improved between 50 and 100 basis points in terms of what we're originating. On credit quality trends, the 30-day delinquencies have been really strong. In the third quarter, we were probably 7.5% C to L, and that's improved by about 200 basis points through the end of January. The team's doing a nice job in what is not an easy environment for consumer credit. We're happy with that. The penetration rates amongst our stores where we're present has been growing very strong. It's about a $450 million portfolio, and that is after a sale of a chunk of the business in the third quarter, which was about $80 million. We're excited about 2024. We think the originations could double. We couldn't be more pleased with how this business has developed over time.

Appreciate that. Just a quick accounting follow-up: where do those reserve or loss provisions flow through the income statement as you think about modeling out the growth in the finance business?

It's all in that one line, other income and expense on the P&L. While growing, it's probably not material enough for us to break that out. I think at some point we'll address that depending on how the growth is, but it's all basically collapsed in that one line.

Great. Thank you so much, guys. Best of luck.

Our next question comes from Rajat Gupta from JP Morgan. Rajat, your line's now open.

Great, thanks for taking the question. Thanks for all the color on 2024 expectations around the new business and the used as well. But curious, is there a range you're targeting for SG&A to grow for the year? In context of the steady new GPU decline and some of the pressures in the used business, how should we think about SG&A growth for 2024? And I have a quick follow-up.

Yeah, I think the thing I would add to that is, as Mike mentioned, you do have some investments in USA as those stores roll out. You don't get to a full run rate of profitability for about a year, so that can dampen the SG&A rate. Also, the investments that Mike has mentioned, strategic investments and advertising, we've seen some inflation there. I would say we probably would be, on a longer-term basis, in the mid-60s kind of level relative to gross profit, but we are paying close attention. As we mentioned, we've taken some modest actions in the fourth quarter to address and take advantage of some delayering opportunities in the regions, as well as to economize some of the support functions. It's a pretty important area for us, and we continue to drive productivity where we can.

Got it. That's helpful color. And just on capital allocation, obviously we've seen a very steady and pretty elevated clip of buybacks over the last few years. Curious how that toggle between M&A and buyback looks today based on what you're seeing in the pipeline for deals and related multiples. Should we expect any shift in strategy there, maybe more towards M&A versus historically buyback?

Are you seeing any changes in multiples or valuations of some of the assets that are out there in the M&A market over the last few months?

Got it. That's helpful color. Thank you and good luck.

Our next question comes from Michael Ward from Freedom Capital. Michael, your line's now open.

Thanks very much. Good morning, everyone. Mike, I think in your comments you mentioned that on the parts and services side, complexity has led to higher content. Can you quantify either some of the content you're talking about or the retention rate you're getting on the parts and services side with the increased complexity of vehicles?

Along with that, could you give an update on RepairSmith and where that stands, and what are your growth objectives with it as you go forward?

And just one last question on the M&A front. You took a look at Pendragon. Does that suggest that as you look out over the next couple of years, expansion outside of the US could be in the cards?

Beautiful. Thank you very much.

Our next question comes from Brett Jordan from Jefferies. Brett, your line's now open.

Hey, good morning guys. On the mobile services question, I guess you're talking about expanding the products offered. Could you talk a bit about the logistics of the mobile services? What can you do in that format? And from a staffing standpoint, cold rainy days probably not appealing to work outdoors, but what are you seeing as far as building out that model?

Okay, thanks. And a quick question on domestic DSI: 66 days. Could you talk about the spread between the manufacturers and that inventory exposure? Obviously, I think there's been a lot of talk about Stellantis maybe increasing their promotional level or decreasing pricing. Are you seeing anything that's changing as far as promotional cadence recently?

Great, thank you.

As a reminder, to ask a question, please press star one on the telephone keypad. Star one on the telephone keypad.

Our next question comes from Douglas Dutton from Evercore. Douglas, your line is now open.

Hi team, thanks for taking the questions. Congrats on the quarter. Two quick questions from me. Just first on the new vehicle PVR point and the normalization that we continue to see. Is it fair to think that there may actually be a higher trough cycle over cycle, maybe remaining at about a 20 to 30% premium over 2019 levels? I'm just curious if perhaps you are beginning to see some structural reasons that a decrease to pre-COVID levels may not be the reality, given the rate of change on profit per unit has begun to slow, as Tom mentioned, as the fourth quarter was actually the best sequential in three quarters.

Okay, that's helpful color. I appreciate you giving the detail there. Just to be crystal clear here, a slightly lower growth from EVs as a lot of us now expect for at least 2024 through maybe 2025, 2026 would actually be a positive. That's the correct way to think about it?

Okay, thanks.

Our next question comes from Colin Langan from Wells Fargo. Colin, your line's now open.

Oh, great. Thanks for taking my questions. I think you mentioned in your comments CFS is supposed to be strong. How should we be thinking about that though? Because I think if there's more leasing, that puts a little bit of pressure on there. Possible normalization of vehicles maybe mass market might put pressure on that. Is that still going to be up year over year, or should we think of it just moderating a bit as we go into next year?

Yeah, thanks for the question, Colin. In my commentary, I was referencing a little bit higher lease penetration in the CFS commentary. I think on balance, leases are creative to what we're trying to accomplish. Maybe you sell a little bit fewer products on a CFS perspective, but it's not massive. It is outweighed by the fact that we have a shot at getting the used car once it comes off lease. It also helps with vehicle affordability. We have typically third-party finance taking a residual risk, so it's net net a win-win for leasing. I would think of it that way. We've been able to manage through with CFS over the years with the higher rate environment.

Got it. And then just going back to your comments to the last question on expecting profitability to sort of normalize to pre-COVID 2019 levels. Is that already pretty much there on the domestics? If I look at the Q4 margin, the percent margin looks pretty similar to pre-COVID. Is that kind of driving some of those thoughts? Those companies that have already restocked a lot of the inventory are already kind of back to normal levels?

Got it. All right, thanks for taking my questions.

Welcome. We currently have no further questions, so I'd like to hand the call back to the management team for closing remarks. Over to you.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.