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Penske Automotive Group Boosts Profitability in a Weak Market

Demand for new vehicles is weakening this year, and that's creating a challenge for Penske Automotive (NYSE: PAG). But the transportation specialist still managed to post improving third-quarter earnings results this week as strength in other areas of the business offset the impact of a soft new-car market.

Let's take a closer look, beginning with how the headline results compared to the prior year:

 Metric

Q3 2017

Q3 2016

Year-Over-Year Change

Revenue

$5.52 billion

$5.15 billion

7.2%

Net income

$94 million

$88 million

7.9%

EPS

$1.10

$1.03

6.8%

Data source: Penske's financial filings.

What happened this quarter?

Recent acquisitions helped keep the revenue base churning higher despite a decline in same-store sales. Meanwhile, Penske enjoyed a solid boost to profitability thanks to growth in the services segment and an uptick in gross profit per vehicle.

Image source: Getty Images.

A few highlights of the quarter:

  • Year over year, Penske sold 10% more automobiles during the quarter for a slight slowdown from the 13% year-over-year growth it managed in the prior quarter. The new-car segment dipped into negative territory, contracting by 2.5%, while the used business soared higher by 25% -- mainly thanks to acquisitions like its recent purchase of U.K.-based CarShop.
  • Stripping out the effect of acquisitions, Penske saw a 1.2% decline in comparable-store sales as the drop in new-car volume overwhelmed growth in the services and used-automobile areas. That overall comps drop was roughly consistent with the prior quarter's 1.7% decrease.
  • Gross profit per automobile ticked up by $90 to $3,383.
  • A big jump in warranty sales helped the service and parts segment expand on its company-leading profitability. Gross margin in the segment rose by almost 2 percentage points to 58.8% of sales.

What management had to say

Executives focused their comments on the big-picture growth they witnessed during the quarter. "I am pleased to report another quarter of record performance for our diversified transportation services business," CEO Roger Penske said in a press release. "Third quarter results were driven by recently completed acquisitions, improving variable gross profit per unit retailed and a 200 basis-point increase in service/parts gross margin."

In an investor presentation accompanying the earnings release, management highlighted the fact that improving profitability in the services and parts segment allowed that division to contribute 41% of gross profit despite only accounting for 10% of sales.

Looking forward

Penske is looking to push deeper into the used-vehicle segment as volume slows for new-car sales. There's plenty of room for growth there, considering that the market is almost three times as big. Executives also like the fact that the used-car niche tends to expand when the new-car side contracts, and so it offers a good opportunity to stabilize and diversify the business. Thus, Penske is hoping to build out its used-car superstore footprint in the U.S. and the United Kingdom.

The good news for the business is that this shift isn't sending profitability lower. Instead, thanks to a mix of improvements in the parts and services and financing segments, Penske's overall gross margin has improved to 15.1% of sales so far this year -- up from 14.7% in the year ago period. Continued growth like that should keep earnings chugging higher even if new-vehicle volumes keep declining.

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Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Penske Automotive Group. The Motley Fool has a disclosure policy.