ValueX Vail 2015 – Group 1 Automotive: Driving Value In An Inflated Market

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Moon Capital Management’s presentation on Group 1 Automotive Driving Value in an Inflated Market from the ValueX Vail, June 24, 2015.

Group 1 Automotive

  • Group 1 owns and operates auto dealerships
    • Third largest dealership group in the U.S. retailing 275,000 new and used vehicles annually
    • 104 US dealerships, 17 UK dealerships, 17 Brazil dealerships
    • Market capitalization of $2.0 billion
  • Recent valuation multiples
    • ’15e P/E: 11.5x

Local Monopolies

  • Dealers provided a great deal of protection in different states (receive long-term operating agreements because they are independently owned and capitalized)
  • Franchise agreements provide geographic exclusivity in densely populated areas
  • Law requires that the sales channel for new cars must be directed through the dealer network
  • Manufacture paid maintenance service required to be completed at dealership
  • Expensive OEM specific tools and diagnostics provide barriers to entry for service techs at independent shops

Economic Moat

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Deceptively High-Quality Business

  • Inventory is financed through vehicle floorplan notes payable from various OEMs
    • Notes accrue like other types of borrowing, but OEMs extend “floorplan assistance” to offset the expense
    • Little inventory risk as the OEMs provide retailers with significant incentives to move inventory and dealers are often paid to carry
  • Dealership decline has improved the competitive environment
    • Dealers down 20% over the past seven years
    • GM allowed to rationalize its dealer network during bankruptcy (cut network by 30%)

Strong National Footprint

Group 1 Automotive

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Business Mix

  • New Vehicle- 54% of sales, 20% of gross profit
    • Roughly $1,850 in gross profit per vehicle, with certain luxury vehicles bringing in more than twice this amount.
    • These per car margins are lower than historical norms
  • Used Vehicle- 30% of sales, 13% of gross profit
    • Roughly $1,600 in gross profit per vehicle
    • Unwanted cars sold at breakeven into the wholesale market
  • Finance & Insurance- 4% of sales, 26% of gross profit
    • Fees and spreads on car loans and leases
    • Purely a fee-based earnings stream for arranging third-party financing, insurance, etc.
  • Parts & Service- 12% of sales, 41% of gross profit
    • The real profit center of the dealership

Finance & Insurance

  • Pure margin business– Group 1 Automotive receives roughly $1,350 per unit for arranging financing, service, and insurance contracts
    • Financing: 1/3 of F&I ($450) comes in the form of flat fees or financing spreads paid to arrange a loan
    • Vehicle Warranty and Protection: 2/3 of F&I comes from fees earned from selling third-party extended warranty, vehicle service, and insurance products

Financing

Group 1 Automotive

CFPB - Headline Risk

ValueX Vail 2015 - Group 1 Automotive: Driving Value In An Inflated Market

  • The CFPB’s intent is to monitor discrimination practices not set pricing—the CFPB agrees that dealers should be compensated for processing financing
  • Any impact is limited to financing—dealer markups represent 1/3 or less of F&I income
  • The expectation is that lenders will be forced to move from dealer reserves (interest rate markups) to flat fees
  • Certain lenders including BMO Harris Bank in Chicago have moved to flat fees (3% of finance amount) with no change of consequence to dealer economics
  • Dealer economics are unlikely to change as they will continue to choose which lenders get the financing business

Parts & Service (The Real Profit Driver)

Group 1 Automotive

  • Gross margins run at 52% (half is service at 70-80% margin, half is parts at 35% margin)
  • Trends in manufacture-paid maintenance have improved economics for dealers—since service is free to customers, the dealer retains the entire service stream
  • Customers may look outside hometown for a new car purchase, but they are a captive customer for car servicing
  • Price & Servicing is driven by the servicing base (0-5 year fleet)

Near-Term Catalysts: SAAR Rebound

Group 1 Automotive

See full presentation below.