Group 1 Auto Stocks: A Disciplined, Balanced Approach to M&A (NYSE:GPI)

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Group 1 Motoring (NYSE:GPI) specializes in the sale and leasing of new and used vehicles. It also offers financing, maintenance and repair services and sells car parts. GPI’s historical financial results have shown solid revenues growth. However, I have noticed that profitability margins are shrinking slightly. In 2Q24 it follows the same trend where revenues grew year-on-year but margins shrank.

Looking ahead, GPI’s outlook is mixed. A disciplined approach to acquisitions and divestitures is expected to optimize its portfolio and support revenue growth. However, the outlook for the US vehicle market appears weak due to high interest rates and a wait-and-see attitude among potential vehicle buyers. Thus, this negative outlook is likely to offset some of GPI’s growth potential. Given the mixed outlook, I recommend a Maintain rating on GPI.

Historical Financial Analysis

Over the past three years, the GPI top line has shown steady growth. In 2021, total revenue was approximately $13.48 billion, which increased to $16.22 billion in 2022. In 2023, total revenue continued to grow, reaching $17.87 billion.

For the US region, revenue increased 10.3% year-over-year in 2023, or approximately $1.38 billion. This double-digit percentage increase was attributed to store acquisitions, as well as higher same-store revenue.

GPI’s U.S. same-store revenue increased 5.7% year over year. The increase was attributed to increased revenue from new vehicle retail, used vehicle wholesale and parts and services, but was partially offset by decreased used vehicle retail and F&I revenue.

As a result of the shortage of new vehicles, prices rose. Coupled with the higher number of units sold, GPI’s new vehicle same-store retail revenue increased year-over-year. On the other hand, the decline in used vehicle same-store retail revenue year-over-year was due to lower prices and units sold. Volumes were negatively impacted by the ongoing shortage of new vehicles, which reduced the supply of used vehicles.

For the UK region, revenue increased 9.5% year-over-year, or $264.4 million. The increase was driven by growth in same-store revenue and store acquisitions. Same-store revenue in the UK increased 7.9% year-over-year, attributable to growth in all revenue segments except used vehicle wholesale. Same-store used vehicle wholesale revenue decreased 0.3% year-over-year.

Turning to GPI’s margins, it showed signs of margin compression over the past three years, but it was modest. Starting with gross profit margin, it contracted to 16.9% in 2023 from 18.3% in 2022. Additionally, adjusted selling, general and administrative (“SG&A”) expenses increased from 61.4% to 64.2% in 2023. As a result, adjusted operating margin decreased from 6.5% to 5.5%, and adjusted net income margin from continuing operations decreased from 4.5% to 3.5%.

Q2 2024 Earnings Analysis

GPI reported its Q2 2024 financial results on July 24, 2024. Total revenue for the quarter increased 3% year over year to approximately $4.7 billion.

For the U.S. business, revenue increased 3.2% year over year to approximately $3.92 billion, compared with $3.79 billion in the prior period. As a result of record new vehicle sales, which increased 7% year over year, new vehicle revenue reached a record of approximately $2 billion. New vehicle revenue increased 4.9% year over year. This strong growth in new vehicles was driven by strong demand as well as GPI’s continued efforts to increase volume.

For used vehicle sales, volume increased year-over-year and sequentially, but gross profit per unit sold (“GPU”) declined slightly. Despite the decline in GPU, gross profit margin on used vehicles increased year-over-year, which GPI attributed to the use of technology to price used vehicles. In addition to the increase in new and used vehicle sales, parts and service revenue and financing, insurance and other (“F&I”) revenue also increased year-over-year. They increased 1.3% and 6.1%, respectively.

Turning to the UK business, total revenue increased 2.1% year-over-year to $775.2 million. The increase was attributed to growth in new vehicle revenue and parts and services revenue, which increased by 8.2% and 9%, respectively. However, this was partially offset by weakness in used vehicle revenue and F&I revenue, both down 4.7% year-over-year.

Moving on to margins, it’s clear that all three were under some pressure. Starting with gross profit margin, it fell from 17% to 16.3%. Adjusted SG&A as a percentage of gross profit rose from 63.2% to 66.3% in the quarter. As a result, adjusted operating margin fell from 5.8% to 5%. Finally, adjusted net income margin from continuing operations fell from 3.6% to 2.8%.

For context, GPI was negatively impacted by the CDK outage between June 19 and June 26. Therefore, this will be clearer if we look at adjusted EPS. In 2Q24, adjusted diluted EPS from continuing operations decreased 16.4% year over year to $9.80.

Acquisitions in the USA

Over the past few years, GPI has demonstrated a disciplined and balanced approach to acquisitions and divestitures to optimize its portfolio. It has consistently acquired businesses that it believes are lucrative while divesting those that do not meet return expectations. Potential acquisitions are evaluated using valuation models that have reasonable growth assumptions.

This disciplined approach ensures that its portfolio includes only the most profitable and scalable dealerships. Acquisitions are made with the intention of expanding reach into new markets and giving existing ones greater size.

To date, it has acquired nine dealerships in the U.S., including one Mercedes-Benz, one Kia, one Hyundai, one Toyota, two Lexus, and three Honda. These brands are considered highly desirable. The acquired dealerships will complement its existing presence in the Hilton Head, Southern California, and Washington areas. Additionally, these nine dealerships are expected to collectively generate annual revenue of approximately $1 billion. For context, these dealerships were already successfully integrated in the previous quarter and are creating value for shareholders.

Acquisitions in the UK

In July 2024, GPI announced that it had acquired four Mercedes-Benz showrooms in the UK from L&L Automotive. These acquisitions will complement GPI’s existing presence north of London. GPI expects the newly acquired showrooms to be fully integrated in the next quarter, delivering additional value to shareholders.

Turning to the deal to acquire UK-based Inchcape, GPI said it expects to close in the coming quarter. The acquisition is expected to generate annual revenue of around $2.7 billion.

The acquisition will further complement GPI’s existing presence in the East and South East of England. It will also enable GPI to enter new markets in Wales and the Midlands and North West of England. For further details, please see the map below.

US Vehicle Market Outlook

Currently, GPI has 147 showrooms in the US and accounts for 81% of new vehicle sales. On the other hand, the UK has 59 showrooms and accounts for 19% of new vehicle sales. Looking at the revenue mix chart, new vehicles accounted for 49% of sales in 2023.

According to Cox Automotive, the outlook for the U.S. new vehicle sales market is mixed. Preliminary data for June 2024 shows new vehicle sales volume down more than 3% year over year. The seasonally adjusted annual sales rate (“SAAR”) is currently pegged at 15.3 million, below the original forecast of 16 million. For context, last year’s June SAAR was 16.1 million.

The weaker result is attributed to slow growth in the automotive industry due to hopes for lower interest rates, uncertainty caused by the upcoming elections and continued downward pressure on prices, especially for new vehicles. As a result, many potential buyers are adopting a wait-and-see approach. Another factor that caused the weaker result is the power outages in CDK that occurred in June 2024.

Relative Valuation Model

According to GPI’s 2023 10K report, the company has provided a list of its competitors. In my relative valuation model, I will compare GPI to a group of competitors in terms of their trailing twelve month (“TTM”) growth prospects and profitability margin. For growth prospects, I will compare their future revenue growth rate, which is considered a forward-looking indicator, and this will give us insight into their growth prospects for the next two years. For TTM profitability margin, I will compare their TTM EBITDA margin and TTM net income margin. These metrics will give us a better understanding of the performance of their core businesses and how they compare to each other.

Starting with the growth outlook, GPI outperformed the median of its peers by a significant margin. GPI has a projected revenue growth rate of 9.28%, which is 2.30x higher than its peers’ median of 4.03%. In terms of TTM profitability margin, GPI slightly lagged behind its peers’ median. In terms of TTM EBITDA margin, GPI reported 5.82%, while its peers’ median is 5.95%. In terms of TTM net income margin, GPI reported 3.04%, while its peers’ median is 3.27%.

Currently, GPI’s forward non-GAAP P/E is 8.06x, which is lower than the median of 9.65x for peers. Given GPI’s performance relative to peers as discussed, I would argue that the P/E should be closer to the peer median. Therefore, I will adjust my 2024 P/E target for GPI upwards to the peer median of 9.65x. For 2024, the market revenue estimate for GPI is around $19.10 billion, while EPS is $38.74. Given my forward analysis as discussed, they support the market estimates as they share the same sentiment. Therefore, applying my 2024 target P/E ratio to GPI’s 2024 EPS estimate, my 2024 share price target is $373.84.

Risks and Conclusions

The upside risk comes from the current wait-and-see attitude that buyers are adopting. Currently, buyers are holding off on buying vehicles as they wait for interest rates to come down as well as for vehicle prices to come down further. In a scenario where the economy improves, buyers will start buying, which will boost GPI’s sales as the pent-up demand is released. Couple this with GPI’s disciplined and balanced approach to acquisitions and divestments to optimize its portfolio, a favorable economic environment will certainly support GPI’s growth.

GPI has been showing steady revenue growth over the past three years. However, profitability margins have been shrinking due to lower gross margin and rising SG&A costs. Based on my forward-looking analysis, GPI’s outlook is mixed. It is very consistent and disciplined in its approach to acquiring and divesting businesses. It does so to optimize its portfolio, ensuring that it achieves returns in line with expectations. However, the current outlook for the US vehicle market seems weak due to high interest rates and a wait-and-see attitude among buyers. The CDK crash also contributed to this in part. Therefore, given GPI’s mixed outlook, I recommend a Hold rating.