It has been a wild rollercoaster ride for shareholders in Group 1 Automotive (GPI). The stock had a 70% drop in price at the peak of the pandemic fears. That said, the stock has rebounded sharply, up 20% year-to-date, and is now trading near its all-time highs.
Recently reported third-quarter sales were down just 3% compared to its prior-year period, highlighting a steep recovery in vehicle sales and services. As a result, management felt confident in reinstating its dividend payment and announcing a new $200 million share repurchase program. Complete use of the share buyback programs would reduce outstanding shares by approximately 9% using recent prices. Historically, the company has return cash to shareholders to the tune of 4% via dividends and buybacks. Share count has dropped from 23.8 million in 2010 to 17.8 million in the most recent quarter.
Interestingly enough, the market has priced GPI at a lower multiple for the past 10 years despite growing net income from $50 million to $204 million. The company has grown EPS and book value at a 10-year CAGR of 14% and 8% respectively, yet its P/E multiple has contracted from an average of 14x in 2010 to 7.3x in 2019. GPI currently trades at a forward P/E of 7x.
In that case, we view management’s capital allocation decision to repurchase its own shares as value accretive. Today, the company would be able to purchase its own shares at an earnings yield of 14%, making good use of shareholder’s capital and clearing management’s own hurdle rate of 10% or above investment returns.
While the company is highly cyclical and we are still navigating through a storm, we believe GPI is a well-managed business. The company has recently refinanced its debt, extending its maturities for more than 5 years thus decreasing financial risk in case of a deep recession. At 7x forward earnings, market expectations are low. If GPI can show consistency, then it wouldn’t be hard to picture a scenario in which the company gets re-rated at a higher multiple. At just 10x earnings, we could be looking at a share price of $174. If not, then we hope management can continuing repurchasing its own shares. We believe GPI is worth the risk.
Quick Business Overview
Group 1 Automotive is an auto dealer with 119 dealerships in the U.S across 15 states, 50 dealerships in the U.K, and 17 in Brazil. The U.S market accounts for approximately 75% of new vehicle unit sales, with heavy exposure to Texas (51%), Oklahoma (10%), and California (7%). The U.K represents approximately 21% of new vehicle unit sales, followed by Brazil at just 4%. Through the company’s dealerships, GPI offers new and used cars and light trucks, financing, and insurance services (F&I), provides maintenance and repair services and sells vehicle parts. While new car sales account for 52% of total sales, it represents approximately 17% of total gross profits. The biggest contributors to gross profit come from F&I fees for arranging financing and insurance contracts through third-party vendors, and Parts & Services, accounting for 18% of total sales combined but 72% of total gross profits.
Source: Investor presentation
GPI also has a well-diversified brand portfolio with Toyota, Volkswagen, BMW, Ford, and Honda comprising approximately 69% of total new vehicle unit sales:
Source: Investor presentation
What we like about GPI
We believe the company’s scale allows them to benefit from efficiencies across its dealership groups and provides a good backbone to future acquisitions. For example, if the company acquires a dealership, it can implement its back-office infrastructure allowing it to leverage its portfolio of add-on services. GPI’s scale also allows them to gather more customer data and consumer trends that the company can then use to improve marketing and customer service, improving relationships and brand image in the community.
There are other levers the company can pull to take advantage of its scale. For example, GPI has expanded its market reach with the introduction of AcceleRide, its online sales platform to effectively compete against Carvana (CVNA) and Vroom (VRM). AcceleRide provides the company with an important lead and sales generator that GPI’s F&I can also take advantage of (add-on service at high margins). We view AcceleRide as a highly scalable platform that should award the company with better profit margins down the line.
Acquisitions play an important role in GPI’s growth strategy. Management looks for profitable, large, well-established dealerships to increase market penetration. The company discloses the benefits of its acquisition strategy as follows:
To capitalize on economies of scale and cost savings opportunities in our existing markets in areas such as used vehicle sourcing, advertising, purchasing, data processing, personnel utilization, and the cost of floorplan financing, thereby, increasing operating efficiency. – 2019 annual report
The market remains highly fragmented in all three geographies. For example, the company estimates there are approximately 16,750 franchised automobile dealerships in the U.S, 4,190 dealerships in the U.K, and approximately 4,020 dealerships in Brazil, representing significant M&A opportunities for GPI in the future. The more points of distribution the company can get a hold of, the more opportunities to offer higher-margin add-on services. That said, alongside dividend payments and share buybacks, M&A remains a capital allocation priority for management:
Going forward, our preference for capital allocation is to add scale to our company through M&A. While the U.S. is our preferred market at the moment, we are open to acquisitions in our foreign markets as well, given the right opportunity. – Q3 call
There is also a high degree of flexibility in GPI’s business model, which was a surprise for us. For example, the company saw its revenues decline by 29% in Q2 and gross profit by 21%, yet operating income, adjusted for asset impairments, was up 6% compared to its prior-year period as the company was quick to reduce approximately $102 million in SG&A costs. GPI’s working capital can also be classified as counter-cyclical, which becomes a source of cash in downturns. For its first half, the company generated $688 million in operating cash flows, compared to $253 million the prior year, as the reduction of inventories became a significant source of cash.
The Bottom Line
Cost control measures allowed the company to report impressive third-quarter EPS numbers even in a declining revenue environment. While SG&A costs will have to eventually come back as the business stabilizes and continues with its growth trajectory, management expects a meaningful improvement in SG&A as a percent of gross profit compared to previous years.
At 7x forward earnings the company looks attractive, yet the stock is not without its risks. Let’s not forget GPI operates in a highly cyclical industry. A low-interest-rate environment has benefitted the company, but a reversal in the trend could severely impact the company as credit becomes harder to get. A downturn is also characterized by an oversupplied market coupled with low demand, translating into depressed margins. And we are still not out of woods regarding the pandemic. Even if a vaccine becomes readily available, there are still many uncertainties.
That said, we believe GPI is guided by a good management team. The company returns approximately 4% in dividends and buybacks and is currently selling at an earnings yield of 14%. We believe there is an opportunity to generate good returns in the stock.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.