Penske Automotive Group, Inc.

And gentlemen, welcome to the Penske Automotive Group third quarter 2021 earnings conference call. Today's call is being recorded and will be available for replay approximately one hour after completion through November 3rd, 2021 on the company's website under the Investors tab at www.penskeautomotive.com. I will now introduce Anthony Fordham, the company's executive vice president of investor relations and corporate development. Sir, please go ahead.

Thank you, Jerome. Good afternoon, everyone, and thank you for joining us again today. A press release detailing Penske Automotive Group's record third quarter 2021 financial results was issued this morning and is posted on our website along with the presentation designed to assist you in understanding the company's results. As always, I'm available by email or phone for any follow-up questions you may have. Joining me for today's call are Roger Penske, our chair and CEO, Shelley Holgrave, our chief financial officer, and Tony Ficcione, our vice president and corporate controller. Our discussion today may include forward-looking statements about our operations, earnings potential, outlook, future events, growth plans, liquidity, and assessment of business conditions. We may also discuss certain non-GAAP financial measures, such as earnings before interest, taxes, depreciation and amortization, or EBITDA. We have prominently presented the comparable GAAP measures and have reconciled the non-GAAP measures in this morning's press release and investor presentation, which are available on our website, to the most directly comparable GAAP measures. Our actual results may vary because of risks and uncertainties outlined in today's press release, which may cause the actual results to differ materially from expectations. I direct you to our SEC filings, including our Form 10-K, for additional discussion and factors that could cause results to differ materially. I will now turn the call over to Roger Ponsky. Roger Ponsky All right.

Thank you, Tony. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report all-time record third quarter results for PAG, including the best quarter in the history of the company. Our total revenue increased 9 percent to $6.5 billion. an income from continuing operations before taxes increased 53% to $476 million, an income from continuing operations increased 44% to $355 million, and related earnings per share increased 45% to $4.46. Although unit sales were impacted by supply shortages in both our retail automotive and commercial truck dealership operations, earnings growth was driven by a 39% increase in retail automotive, 135% increase in commercial trucks, variable gross profit per unit retailed, also 4% increase in retail automotive service and parts gross profit, and a 230 basis point reduction in SG&A to gross profit, and 15 million in lower interest costs. coupled with an increase in commercial truck dealership EBT of 106% and an 83% increase in earnings from Penske Transportation Solutions. This demonstrated the continued strength of our investment and the benefit provided by our diversified business model. Looking at our retail automotive operations on a same store basis for Q321 versus Q320, Units declined 8%. However, revenue increased 7%. Gross profit increased 18%, including 180 basis point increase in our gross margin. Our variable gross profit increased 39% to $5,769 per unit compared to $4,152 last year. Looking at Car Shop, we now operate 22 locations and expect to open one additional location by the end of the year. We recently added locations in Layton Buzzard and Wolverhampton in the UK, and our Scottsdale location opened this week. During the quarter, Car Shop unit sales increased approximately 1% to 18,451 units. Revenue improved 24%. to $438 million, and gross profit per unit increased 12% to $2,668. Our current annualized run rate is approximately 70,000 to 75,000 units, representing revenue of $1.6 billion and an EBT between $45 and $50 million. Turning to the retail commercial truck dealership businesses, our premier truck group represented 11% of our total revenue in the third quarter. Retail revenue increased approximately 26%, including a 6% on a same-store basis. On a same-store basis, retail gross profit increased 40%, including a 10% increase in service and parts. Earnings before taxes increased 106% to $48 million, and the return on sales was 6.7%. The Class 8 commercial truck market remains very strong. And during the third quarter, North American Class 8 net orders increased 28%. And the backlog increased 179% to 279,000 units, representing a 13-month supply. Based on the current industry forecast, retail sales are expected to increase over the next two years. and provide tailwinds to our commercial truck and truck leasing businesses. Turning to Penske Transportation Solutions, which we own 28.9% of PTS, which provides us with equity income, cash distribution, and cash tax savings. PTS currently operates a fleet of over 350,000 vehicles. For the nine months ended September 30th, PTS generated $8.2 billion in revenue and $949 million in income, or a 12% return on sales. In Q3, PTS generated $2.9 billion in revenue, an income of $409 million, or a 14% return on sales. As a result, our equity earnings in Q3 increased 83% to $118 million. Our full service leasing and contract sales were up 8%. Our commercial rental revenue is up 51% and our utilization hit 88% with an additional 14,000 units on rent. Our consumer rental is up 27% and our logistics revenue increased 27%. Our gain on sale of used trucks is up 143% as the strong freight environment and a supply shortage of new trucks is certainly driving a demand for used vehicles. I now would like to turn the call over to Shelly Holgrave, our Chief Financial Officer. Shelly?

Thank you, Roger. Good afternoon, everyone. Looking at the PAG balance sheet and cash flows, the balance sheet remains in great shape. At September 30th, we have $119 million in cash, and we ended the third quarter with over $1.2 billion in liquidity. When looking at our capital allocation, we maintain a disciplined approach that focuses on opportunistic investments across both our retail automotive and commercial truck businesses, capital expenditures to support growth, including our car shop growth strategy, delivering a strong dividend to our shareholders, reducing debt whenever possible, and share repurchases. In fact, year to date, we have repurchased 2.5 million shares representing approximately 3% of the total shares outstanding. Year to date, we generated 1.3 billion in cash flow from operation. We invested 157 million in capital expenditures, including 18 million to acquire land for future car shop expansion. Net capex was 84 million. At the end of September, Our long-term debt was 1.4 billion. We have repaid 922 million of long-term debt since the end of 2019. In addition, we have either repaid or refinanced our senior subordinated debt to lower rates while lengthening the terms to take advantage of current market conditions, which has contributed to a $34 million reduction in interest expense so far this year. These initiatives have lowered our debt to total capitalization to 27%, compared to 33.7% at December 31st and 45.6% at the end of 2019. Our leverage ratio sits at .9x, an improvement from 2.9x at the end of 2019. At the end of September, our total inventory was 2.6 billion. Retail automotive inventory is 2 billion, which is down 937 million from December last year. We have a 19-day supply of new vehicles. Our day's supply of premium is 22 and volume foreign is 9. We expect the current supply challenges, coupled with strong demand, to keep our new vehicle supply at low but manageable levels. Used vehicle inventory is in good shape with a 40-day supply. At this time, I will turn the call back over to Roger.

Thank you, Shelly. Moving on to our digital initiatives, we continue to grow, expand, and enhance our digital footprint, including the introduction of new tools and technologies to offer our customers a hybrid, customer-driven shopping model. Depending on their preferences, customers can purchase either fully online, in-store, or any combination of the two. We will also deliver vehicles directly to a location desired by our customers. As part of our omnichannel customer experience, we strive to be a leader in online reputation, including online customer reviews and star ratings on Google. Looking at our other digital tools, we retail 2,550 vehicles, or 4.3% of our U.S. unit sales, and 14% of our customers use Preferred Purchase in their buying journey. Using the Sittner buy-on tool in the UK, a customer may reserve a car for 99 pounds, apply for financing, receive instant credit approval, obtain a guaranteed price, and pay online. During the quarter, we sold 3,700 units using this platform. When you combine all of our digital tools, including new technology available at CarShop, A customer may perform any part of the transaction online or may use these tools to shorten their visit to the dealership. Looking at corporate development, in addition to the 220 million of year-to-date share repurchases, we completed acquisitions totaling 600 million in annualized revenue through September 30th. In October, we acquired the remaining 51% of our Japanese-based joint venture of premium luxury automotive brands, which will add $250 million in consolidated annual revenue. We have another $300 million in annualized revenue of deals in our pipeline that we expect to close either in the fourth quarter or early in 2022. We also opened up a new Porsche dealership in Washington, D.C. earlier this year, and we have three other open points under construction. We increased our car shop locations by five, and expect to open one additional location by the end of the year, bringing our total to 23 locations. We remain on track with CarShop to retail 150,000 in unit sales and generate $2.5 to $3 billion in total revenue and earn $100 million of EBT by the end of 2023. As we look across our deferred portfolio of businesses, we continue to target organic, and acquisition growth, as well as further operating efficiencies to continue to grow and expand our businesses. Before I close, I'd like to congratulate the 35 US dealerships that were named by Automotive News to the 100 best dealerships that work for listing. We had more dealerships on the list than any other automotive retailer, including six of the top 10, 12 of the top 25 in the 2021 ranking. Our Audi of Turnersville store is ranked number one in the country. Additionally, seven PAG dealerships were ranked in the top ten nationally, including the top three places for their efforts to promote diversity, equity, and inclusion. We're honored by these accomplishments and are extremely proud of our team for their commitment to drive the passion and the efforts in working together to be one of the very best. I'm also pleased to announce that Penske Automotive Group was ranked first on the listing of U.S. public dealerships teams in the 2021 Automotive Reputation Report published by reputation.com. In closing, our business remains strong and our record performance demonstrates the benefit of our diversification. I'd like to thank our team for outstanding results in producing all-time record here for Penske Automotive Group. Thank you again for joining us on the call today for your continued confidence in PAG. At this time, I'll turn it back over to the operator. Thank you.

Thank you. Ladies and gentlemen, at this time, if you would like to ask a question, please press par 1 on your telephone keypad. And to withdraw your question, press the pound key. One moment for your first question. Your first question comes from Rick Nelson with Stevens, Incorporated. Your line's open.

Thanks a lot. Good afternoon, Roger, Shelley, Tony. Hey, Rick. I guess, you know, to start, you know, PAG has been less, you know, we've seen some major deals across the landscape announced recently. PAG has been less active, you know, have been strengthening the balance sheet quite a bit. I'm curious, you know, your view of the M&A environment and the multiples and, you know, the pipeline for PHA.

Well, I think it's been an active marketplace, Rick, certainly with some large deals taking place across the I don't want to retail space is we know there's 18,000 dealerships and 32,000 franchises. So it's a big sandbox, obviously. I think fragmentation provides opportunity for consolidation. With the investment required today, I think there's a number of smaller dealerships will become available. I think the deals that we see the bigger deals are expensive. And many of them require capex and also then would provide some input from the standpoint of framework agreements with the manufacturers and Basically, over the last 12 to 18 months, I think we've looked at our balance sheet. We've looked opportunistically at things that we could buy and invest in, and I think you've seen that with roughly $850 million of revenue that we've completed as of today with another $300 million under contract. We're growing car shop organically. We'll have added six locations. We have, as I mentioned earlier in my remarks, three dealerships under construction that are new points. And I think what we'll do over the next 12 to 18 months is look at growing probably at about 10%. That's $2 billion a year. And that would be divided not only on a same-store basis, but also in acquisition. And at the moment, you know, we see the opportunity from the commercial truck standpoint that these multiples are quite a bit less than the retail auto and would Straitliner, who's our lead OEM, looking at consolidation. We're taking advantage of that as we go forward when you're looking at businesses that are returning over 6% on sales. So I think that at the end of the day, we'll continue our CapEx from a capital allocation. I think Shelly mentioned dividends and share repurchases. But we're going to be opportunistic. We certainly are not getting out of the retail auto business for sure. And our commitment to car shop to grow that I think is key with our mission that we have to reach 150,000 units by the end of 2023. So, you know, I think the deals that are done are great for our peers. And to me, it just shows you the opportunity and the profitability in this business.

Thanks, Roger, for that caller. I'd also like to ask on inventory, supply new, 19 days, any visibility at all into future flows? Do you think we're at a low watermark here with inventory, or can we start to climb?

Well, we were 12 days here in the U.S., and as you look at the international, add it all together, to get to our total number. You know, I've had conversations as late as yesterday talking about inventory going out. I think we'll see in the premium luxury side, we'll see some opportunity for more vehicles coming in November, December, but it's a smaller amount. And quite honestly, everything that comes off the truck is sold or selling into the pipeline. And I think we're going to see that, you know, for the next 12 months. I don't think the supply chain is going to get fixed. And the OEMs are prioritizing the models where they make the most money. We see that in the UK. The market was down 33% there lately. And when you look at that, it's not because there's not demand. They're just not building the small people cars because they don't get the margin on those. So I think there's different levers that the OEMs are pulling at this point. But I think it's going to be business as usual here. Tight inventory. You know, all the dealer groups, we're all looking at ways we can sustain our customers. We're looking to the finance companies and leasing companies to extend leases so we can keep our customers stickier with us as we go forward and being able to order cars for them when they're available. So at the moment, I think the premium luxury people and everyone else, you know, are focused on supply chain, and they're building cars that don't have some of the maybe the additions and accessories that we normally would have. But overall, we outperformed the market here really looking at the market was down 13, and we were only down three. So we feel good where we are, and I think that the market will certainly be a little choppy here for a while.

Very helpful. I'll turn it over to others. Thanks, and good luck. Thanks, Rick.

And your next question comes from John Murphy with Bank of America, Maryland. Are your lines open?

Good afternoon, Roger, Tony, and Shelley. Thank you for the comments here. Just a first question in following up on Rick's first question on cap allocation. I mean, some of the other dealer groups are being much more aggressive in actually taking on leverage. And right now, you're taking down leverage by repaying debt. you know, but you're allocating capital towards growth. So I'm just curious, you know, one, if you can maybe just give us a quick summation, meaning that 12 to 18 month goal of 10%, you know, revenue growth, how much of that is same store and how much of that is acquisition? You know, and two, if you decided to get more aggressive with the balance sheet, I'm curious if you consider doing that, you know, where you think the capital would be allocated and, you know, are you kind of loading up here for something bigger or better opportunity? I mean, what's the thought process versus other dealers that we cover that are kind of laying it out on the balance sheet, to put it politely?

Well, let me say this. You know, we're diversified, so we've got a number of areas that we can, you know, actually apply our capital. And I think from a capital allocation perspective, right now we're looking at the cost of acquisitions. There's no question on the commercial side, truck side, we see that as... Certainly an opportunity for us. I mentioned it earlier that Freightliner is positive about us growing. I think from a growth standpoint and the 10% I talked about, I think you'd look at 50-50 just to keep it simple. And there's no question that when you look at our liquidity, we're at about $1.2 billion plus. We've got $100 million of cash. So, you know, we're in a great position. Nothing out on our credit lines at the end of the quarter. We have our two bonds, which is roughly $1.2 billion. Those are six years, I think, before they're paid off, and $3.75, so the rates are good. And we have some mortgages of a couple of hundred, so at the end of the day, I think we're in great shape. But from a standpoint, I'm looking at the market right now with supply chain interruptions, not knowing where these multiples are going to go, because I don't think when you're looking at pricing some of these deals and looking at a trailing 12 you're looking at probably the biggest market most profitable market we've had in many years so I think I want to stay keep my leverage down and my opportunities in front of us we can move you know right away and we could lever up to 2.5 to 3 if we wanted to for a big deal but I have nothing right now that would say that we're in that mode but we get a chance to look at these and In the past, we've passed, and I think we'll be very selective. And if we have areas where we can add on, where we have scale and consolidate, you know, we'll be in there with a big number. But at the moment, I think we're going to take a patient look and try to understand what this market's going to bring us in over the next 12 months.

And just to follow up to that, I mean, if we think about 5% growth via acquisitions over the next, you know, 12 months or so, I mean, is that a – the kind of redeployment you think would be something we should think about go forward beyond that or because you're taking leverage down, you know, that might be somewhat conservative and then over time, there's opportunities to avail themselves, you know, and you've got the balance sheet firepower, you know, to go after them. You know, that may end up proving being, you know, a somewhat conservative way to think about acquired revenue growth going forward.

Yeah, I would say it's conservative and I think if, look, we have to put a number down and work towards a number. And I think that's realistic when you're looking at what our same store revenue is from a year to date and looking into 2022 and then looking at what we have potentially from an acquisition standpoint. I think that's realistic. We've got these new points opening. We've got the opportunity from a car shop perspective to grow same store. And on the other hand, if there's a big deal out there, that's how we built the company. Remember, we were in pretty much of a buying mode early on, and I think that what we'll do and see just exactly what's available to us. I think right now, when you look at Car Shop, we have the ability to grow that many times over with capital, and it's a lot less. We don't have the structure in front of us, the framework, and some of the areas that we have to deal with with the OEMs with Car Shop. But I think the brand has really taken off both here domestically and internationally. So that's certainly going to be a focus.

Got it. Then to the second question on SG&A, you've taken a lot of heads out. I'm just curious where you think SG&A costs will go. I don't know if you could talk about in absolute terms or percent of gross. I know that's kind of hard because there's a lot of moving pieces, but how do you think we should think about SG&A to gross or SG&A costs in total going forward?

I looked at SG&A during the quarter, and it's interesting. Overall, we've taken about 8% of our people out since pre-COVID, just from an overall standpoint, and almost 2,000 people. When you look at SG&A, our comp was up about $100 million during the quarter. That basically was based on variable comp and the margins that we have. When we look at SG&A, we'll probably be in the low 70s. We're better than that today. We've come down from 77, but I don't want to mislead anybody. I think the growth is driving a much better looking number than it might be on a going forward basis, but I would say low 70s. Got it.

That's helpful. And then just lastly, I mean, I appreciate the details on digital initiatives, and I'm just curious if you could talk about a little bit what you're doing with Cox now, because that's a much newer initiative. But also, as you think about that and your other efforts and how they ultimately will dovetail with some of the efforts of the automakers that are, you know, kind of trying to create this digital overlay and interaction with the consumer, which is almost analogous or similar to what a lot of dealers are investing in. I'm just curious how you think, you know, one, what you're doing near term with Cox and two, longer term. How do these systems ultimately interface, interact, or maybe, you know, compete with what, you know, the automakers are doing to some extent? Because they're getting pretty heavily invested as well in their digital efforts.

Well, I think that, you know, we kind of have a hybrid approach, really, when you look at it. You know, we've got third-party sites. We've got the OEM digital sites, and then we're also using social media. But at the end of the day, and you look at the cocks We spent about a year or so with Cox, and I think if anybody's used the product at all at this point, it's excellent. We only have 2,000 units on the platform right now because it's in the early stages, and we've done about 300 units of sales as both either people getting off the site and moving into the dealership or directly all the way from end to end, which we think is a good start with very little issue. From a CSI perspective, we've got lots of compliments on that platform. And I know Cox has got, they're looking at it, they're watching it. It's very important to them that it's successful. But on the other hand, one of the things that I've cautioned our people, we see all these opportunities, but probably the thing that I want to do most is partner with the OEMs because they're all rolling out an e-commerce platform. So it's going to be part you know, of your relationship. It's like your floor plan. It's like some of your financing. I think you're going to want to use their platform. And today, Toyota has SmartPath, and Lexus has Monogram, and Mini has Anywhere. So these are all in a position today that I think we've got to take a good look at. And we're in the process of signing up for those as we go forward. So to me, I think that's going to be key. And I think the Internet sales – you know, are going to be key, but we're still going to have people because of the premium luxury brands that we have are going to come in and kick the tires for sure. But I think the omni-channel certainly is just not, you know, selling vehicles. You think about service appointments, you know, online payments, you know, this is key. You know, we had today between our BDCs and our online service appointments over 500,000, you know, when you look at that in the quarter. And the online payments continue to grow. I think we collected almost $50 million during the quarter on online payments. So to me, this is key because the average payment is almost $1,000. So we're using this online channel, obviously, for more than just selling new and used vehicles.

Great. Thank you very much. Thanks, John.

Your next question comes from Stephanie Moore. with tourist airlines open.

Hey, Stephanie. Hi.

Hi, good afternoon.

Hey, Stephanie. I wanted to talk a little bit. You did speak on just what we're seeing from these underlying trends on the auto retail side, supply chain disruptions, but maybe you could touch a little bit on what we're seeing on the commercial truck side and the freight environment, obviously having a nice benefit to both your JV as well as the commercial truck retail business right now, but maybe you to talk about the longevity you expect of some of these trends as well as maybe some of the positive attributes that might come out as a result of this, even as environment, whether it's on pricing or the used truck market, anything like that. Thank you.

Well, I think we've got to go back a little bit. As you know, we have electronic logs now for drivers And that was instituted here several months ago. And what happens where people are running two logbooks and being able to run maybe 12 to 18 hours a day, they're not able to do that now without brakes. And what that's done, that's certainly in a position that has created more driver requirements, and yet we can't get drivers right now. And with that, there's a shortage to move goods, and 85% of the goods are moved by truck here in the U.S. And from my perspective, We see the truck business is core. When you look at the demand with the OEMs, almost a 13-month backlog. That's for heavy duty from the standpoint of 279,000 units at this point. And that's going to drive this business for the next 12, maybe even 24 months. And that's what's driving the used truck prices up because today most of the fleets are can't get their new trucks right now, so they're running their old trucks maybe another five to six months, and that's also helping drive this used truck value, but I don't see it slowing down, and to me right now, the biggest issue is the number of trucks that are sitting at these OEMs without parts, and I know Freightliner right now is having a big focus on completing the trucks that are on the ground, which will help us, and I think that's going to take some of this backlog down, but Based on what we're hearing, the first quarter, we're probably going to end up delivering trucks that should have been delivered in the fourth quarter. So that's going to push this whole supply chain out at least 90 to 120 days late from where it should have been. So I see it obviously being a positive for us from the standpoint of our rental business on the truck leasing side because people need extra equipment. And that's the business we're in. It's commercial rental.

Absolutely. That's really helpful. And then, you know, I think over the last year, really seeing the strength, whether in the capital allocation, whether it's repurchasing shares, obviously raising the dividend, debt pay down, you know, as you look forward, I think opportunistic M&As already come up on this call. But where do you stand in terms of, you know, continued debt pay down, share repurchases, you know, as we look out for the next 12 months?

Well, from a debt pay down perspective, we really have mortgage debt that we have that's variable that we can pay some of that down, which we would. And I think, you know, we've got dividends, which, you know, we continue to grow the dividend base. And from a share repurchase perspective, that's going to be something that we have $70 million right now of authorization from the board. And we just really moved that to $250 back in July. So we'll sit with our board in December, and we'll look at that allocation going forward. So we've got share buyback. You know, we've certainly got M&A, which, you know, we've talked about strategically, maybe from a commercial truck perspective opportunistically when we look at the retail automotive side. And then we're going to absolutely develop and invest in the car shop part of our business. So I think there's plenty of areas that use our capital. But again, we're going to keep our leverage where it is. And then if there's a big deal, we can step up. We don't need to go to the market for extra capital. We have $1.2 billion to $1.3 billion right now available from the standpoint in our credit lines. And that's without any other leverage of any other assets. We only got about 24% of the book value of our real estate being mortgaged at the moment.

Great. Well, thank you so much as always.

Thank you.

Your next question comes from Mike Warrant with a benchmark company. Your line's open.

Thanks very much. Good afternoon, everyone. Is there a way to rank the capital requirements when you look at these growth investments, whether they're open points, truck distribution, car shop, M&A? Is there a way to rank which ones are from either high to low or low to high as far as capital requirements when you do those?

Well, from a car shop perspective, I'm going to just take it as they come to mind. We have significantly less investment in a car shop location. We're just opening one in Phoenix. We just opened one this week, which probably the investment is about $12 million total. And the one over in New Brunswick was about the same. And I think when you look at those locations and the returns, they're much greater than they would be if we – had to build a premium luxury store in the same place. But I think it's lower investment. When you look at return on sales, we're in the, say, 2%, 3%, 4% on the retail side. I think from a truck perspective, commercial truck is looking at somewhere between 5% and 7% return on sales. So that certainly would become also a priority for us. The opportunity also, which we haven't talked much about, is in Australia. As we start to grow that, continue to grow that business, you know, as we have defense, we have big power gen capabilities there. We certainly have our on a highway and our mining businesses there. And we continue to invest in equipment and facilities out there. And today, you know, we have some single source contract with the government on defense going forward. So our capability there to get more vertical, With the government, it will be certainly an area we would spend some money on in order to have those long-term five- and ten-year contracts, and those are quite profitable also.

With your joint ventures, bringing them in from Japan, does that open up additional opportunities in Japan with your partners?

There's no question. Mitsui is a partner of ours. We're a big player with Toyota and Honda. We wanted to be in that market. We did a joint venture with Nico Remke. there a number of years ago, and what we wanted to do was get our feet wet there, understand what was the requirements from an accounting perspective, from a controls and risk. We've operated in that business now for probably about five or six years. We're the Alpena distributor for all of Japan. We're a big BMW dealer there. We have Rolls-Royce and Ferrari, along with many. And I think when you look at it, the OEMs have come to us a number of times wanting to us add to our platform, and we would expect to do that with the management team we have in place. Our former partner has moved to non-executive chairman, so we still have some oversight with him, but we have a gentleman that's been there now for four years, really, learning the business, came from the OEM side, an American that's learned Japanese, has a Japanese wife, and has really done a great job, so we think we're in a position with the controls in place now, and we'll go forward, and that'll be a growth area for us.

A couple of questions for Shelly. Shelly, maybe starting off first, when you look at your debt ratings and you're right on the cusp of investment grade, is there any plan or does it benefit you to get moved up to investment grade or is that just irrelevant?

No. Given the strength of our balance sheet, we can certainly have those discussions with rating agencies, like you said. S&P upgraded us to BB Plus in May, and we're at BA.1 with Moody, so just below investment grade right now. It's not a priority for us, but it never hurts for us to have those discussions. Never hurts. Yeah. Our lease adjusted leverage ratio is now at 2x when the requirement is 3, so we do have some cushion, as Roger had mentioned earlier. Clearly, there's upside from an interest rate perspective, probably about 100 basis points on future bond offerings. Yeah, we're just evaluating the potential policy restrictions. So as we look at our capital allocation strategy, we wouldn't want to risk a potential downgrade, but we wouldn't want to pass up a significant opportunity either.

What is the impact on cash flow as inventories replenished over the next year or two?

Well, we floor the majority of our inventory purchases, Mike, so the impact is really eliminated, and we're not expecting, as Roger mentioned, a quick return to inventory, if at all, to prior levels. So we continue to see a buildup of pent-up demand, particularly with the lease returns starting to come off those stronger years, and as we've seen, the production returns will be gradual, so very minimal impact.

And just one last one. Some of your peers are starting to get into the finance business. You're generating so much cash, and it looks like it's going to be at similar levels at least through the end of 22. Are you considering that at all, or have you looked into it, the pluses and minuses of starting a finance arm?

We have from time to time evaluated those pros and cons, Mike. The decision typically comes down to the return of capital. And as we've talked about, we're experiencing some pretty great returns on PTL or PTG acquisitions, and even our recent Mercedes store that we acquired here in April. So plus the majority of our transactions on the premium luxury side are in the leasing side, and we have an 80% penetration rate with our new vehicle sales. So when you look at that and our small subprime business, I'm not sure starting a finance company really makes a lot of sense right now.

Yeah, Mike, we've looked at it. In fact, it was a discussion item at our latest strategy meeting. We can't borrow money like the banks can. So in order for us to get the kind of return we want, we're going to have to go down in credit rating in order to be able to attract the kind of returns we want. And it starts to burden your balance sheet. Certainly we can securitize over time. Then the lease account or the accounting requirements there, we have to take in the income, you know, over 30 months, 40 months, or 60 months, depending on the term of the contract. So I would say right now, when you look at our subprime business, only 6%. So I think we're in a good position. It's something we continue to look at. We've seen other people take that on. And, look, we're different. And I think that, you know, we'll probably not be getting into that business at this particular time.

Andrew, just to follow up earlier, when you talk about these open points, and I think you have three open points, is that something we can expect to see more of? And that's not just U.S., right? That's Europe as well?

Right. Well, you know, obviously we've got open points in car shop, which we can designate those. Right. You know, we've been, you know, with the OEMs, we've got two open points in Austin. We, of course, had the open point in Portia. We got a couple open points in the UK. So I wouldn't say you're going to get three or four every year. But, you know, where we have scale and where we've proven to be a good operator, we've had this opportunity. We apply for those, and we've been successful. So we see those as a good way to grow. We're growing the way we want. We're able to build purpose-built facilities that meet the CI and not have to jump into a a bunch of corporate identity when you're buying a bunch of stores that are not brand new. So we see that obviously as a positive.

Thank you. Thank you very much.

Thanks, Mike. Thanks.

Your next question comes from Rajat Gupta with JP Morgan. Your line's open.

Great. Thanks for taking the question. You know, sorry to ask you once again on capital allocation and, you know, just balance sheet leverage. You're going to be generating a significant amount of free cash flow over the next year or so given this elevated margin profile. It doesn't look like the M&A multiples on the automotive retail side seem attractive. You already have some capital committed for car shop, which is kind of well understood. Given we are in this unexplored space for much longer, Would you consider, like, a big buyback? You know, you don't even have to add, like, a ton of leverage to do, like, you know, maybe even close to a billion, given you're generating more than, like, 800 million or so of free cash flow. Just curious, you know, what's your take on that, and would you consider doing, like, a big buyback in the interim, given this excess level of free cash flow? And I have a couple of follow-ups. Thanks.

Well, I think share buyback is something that we discussed with the board, and as I said earlier, that we'll have that discussion in our December meeting. That's always an option for us, you know, on a going-forward basis. We've been pretty much consistent, you know, increasing our dividend a penny a share as we've gone forward over many quarters. And, you know, we had $250 million of buyback authority. We thought that when you started looking at options for our capital, that share buyback was certainly – prudent during the last quarter. Now, those same conditions could take place in the future, and that would be reviewed by the board, and we'd make those decisions at that time.

Got it. And just on shifting gears to GPUs, on the new vehicle side, I'm assuming that the absolute GPU continued to get better through the course of the quarter, and you're likely exiting the third quarter at a higher run rate than your average. Just based on what you're hearing from OEMs, the supply, can we sustain this kind of high 5,000 number for a few more quarters? Or do you see this coming back to more normal? Not normal, but do you think third quarter is the peak here?

Well, I think I've had that question before. And when I look at entering the quarter, And in exiting the quarter, there was no question that new vehicle grosses went up month to month. July, August, and September, also our use went up. I think at the end of the day, when you look at MSRP, that's the manufacturer's sales price, suggested sales price, there are some people who are selling above that. I think that that's very dangerous territory right now. Because what it does to your customer over a long period of time, you really don't know. So I think that on a used car side, we're probably close to the top. And because we have nothing on the ground and you're selling into the pipeline, you're going to continue to hold good margins. Now, whether it's within $100 what we have today, I think that the sustainability of the grosses right now will be dependent on supply.

Got it. Got it. That's helpful. Thanks for all the color. I'll jump back in here. All right. Thanks, Rajat. Yeah, thank you.

Once again, if you would like to ask a question, please press star 1 on your telephone keypad. Your next question comes from David Weaston with Morningstar. Your line's open.

Hey, David.

Hey, everyone. Thank you. First on the truck space, Roger, you talked earlier about it's just taking too long for new truck orders to get met. So is that purely the chip shortage, or are there some supply chain issues on top of that that are more of a problem?

Yeah, listen, people don't realize they're air freighting tires now, lots of things other than just chips on the heavy-duty truck side. So I think the key thing here as we look at it – When you look at the manufacturing businesses and plants are losing their people, they've lost people and trying to crank back up again. You know, there's some human capital requirements that they're meeting. And again, they have to be trained. I talked to one OEM the other day and I said, any one day they could be down 25% of their workforce. So how do you run your plant when a quarter of your people don't show up on Monday morning? So I'm not saying this is any particular truck OEM, but this is pretty much what you'd see in the marketplace. But right now, there's a big demand for heavy and medium duty trucks, and the supply isn't there. And quite honestly, we've seen the impact of that on our Penske Transportation Solution business, because with our 88% utilization rate on our tractor base, which is up 14,000 when you look at total units, You know, it's amazing. And we don't see that slowing down, really. Some of the consumer rental, which is the one way, that will come back probably 15% to 20% in Q4. But overall, I think you're starting to see the deliveries of the heavies are going to be pushed out into Q1 and Q2. And that's just strictly availability of all components. And when you have tens of thousands of units sitting on the lots of the OEMs unfinished, they've got to focus on those before they build more new trucks. They just don't have the space.

Thanks. That's helpful. In the UK, consumers are dealing with a lot of shortages, particularly even fuel. Is that causing a lot of havoc at your stores in terms of people not wanting to buy a vehicle?

I don't see that. I think electrified vehicles have gone up. If you look, I don't have the numbers right here in front of me, but there's no question that... Demand is still strong and there's been a bigger movement to electrification. Maybe some of that has to do with the shortage of fuel, but the big issue there is drivers to drive some of these big rigs because a lot of them went back to Western Eastern Europe when COVID hit and haven't come back. In fact, I think Johnson was giving some permits for 5,000 people to come in as drivers in order to drive some of this equipment, which certainly has had an issue. Hybrids seem to be what's the hottest sector in the UK right now because that gives you the opportunity to go into cities like Los Angeles and Birmingham and places like, excuse me, into London and Birmingham, you know, with a hybrid vehicle. And most people have to pay a tax when they buy an ICE engine. And if you have an electric vehicle, you pay no taxes. And that's In the company cars, that's a big factor from the standpoint of what they pick. So that's also driving electrification.

Okay. And PTS, the press release cited operating expense reductions. Where are those primarily coming from?

Say that again. You said PTS?

Yeah. There's an operating expense reduction cited in the press release. I was just curious if that was coming from operational moves or headcount reductions.

Headcount. It's efficiency and headcount across our business. Roger mentioned we're down about 2,000 people or 8%, 9%, David, across our business. It wasn't specific to PTS. It was specific to our overall business.

Okay. And last question. I'm asking everybody this. Are you seeing any change compared to a few months ago, whether it's a Car shop or on the traditional side, are consumers just getting fed up with the shortages and just saying, I'm not going to get a use, I'm going to wait until you have more new inventory? Or conversely, are people more desperate?

I think one of the things on the use side is the prices are getting so high, it's almost like sticker shock. They can almost buy a new car, but of course they're not available. So some people might be sitting on the side in order to get pricing right and then availability of new vehicles too. If you have another option, that's what I'd see right now. Okay, thank you. All right, David, thank you.

Once again, if you would like to ask a question, please press star 1 on your telephone keypad. All right, there are no further questions at this time. I'll hand the call back to Roger Penske.

Thank you, Jerome, and thanks, everyone, for joining us today. We'll see you next quarter.

Thank you, and that concludes today's conference. Thank you all for joining.