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

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

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

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

CFPB – Headline Risk

• 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)

• 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

See full presentation below.