Penske Automotive

Penske Automotive's stock closed at $223.44 on July 29, up 1.6%, after the firm reported second-quarter adjusted diluted EPS of $3.62 that beat the $3.42 LSEG consensus. Same-store retail automotive revenue increased 5.7% with all major segments growing.

Why it matters: As discussed in our July 22 note, Penske Automotive has an offer to go private from Penske Corporation and Japan's Mitsui at $210 per share. The stock reaching $226.89 on July 29, in our view, could pressure the PAG board to ask for a higher offer. It was good to see the company post same-store retail automotive revenue growth in all segments except wholesale. Other dealers that have reported this week have posted declines, other than for service, on a tough comparable versus pull forward demand from tariffs a year ago. The truck business is seeing a big increase in used truck demand, with used units sold at the firm's 35 stores (nearly all Daimler Truck brands such as Freightliner) up 64.8% year over year, which helped keep segment gross profit only down 0.6% as new truck gross profit fell 17.2%.

The bottom line: We still expect narrow-moat Penske Automotive will go private, though it may be at a price higher than $210. For now, we are leaving our fair value estimate unchanged at $210 per share, reflecting a probability weighted approach with the $210 price weighted at 80% per our July 22 note. We think Penske Automotive is in great shape for growth regardless of whether it is publicly traded or privately controlled. All three segments have long growth runways, in our opinion, and the Australian distribution business has a variety of growth channels, including energy storage. Share buybacks continued in the quarter with $42.5 million spent at $160.31 per share on average. The authorization has $221.2 million remaining and the firm's total liquidity is $1.4 billion. Capital allocation will remain flexible between buybacks, dividends, and acquisitions.

We are increasing our Penske Automotive Group per share fair value estimate to $210 from $206. In light of Penske Corporation and Mitsui on July 22 offering to buy out the rest of Penske Automotive that they don't already own (72.2% combined stake as of April) for $210 per share in cash, our fair value estimate is a probability-weighted one reflecting our belief the deal will close as discussed in our July 22 note. Our $210 fair value estimate is based on a weighting of 80% at $210 per share, 10% at our prior valuation of $206, and 10% at $215. The $215 is to allow for what we see as a small chance that minority shareholders receive an additional premium. We see some chance of that occurring given the stock traded above the $210 offer price on the morning of July 22.

We model $1.5 billion in annual revenue acquired for 2026, then $400 million-$1.7 billion in annual revenue acquired for 2027-30. We think the company’s prospects remain very bright, as growth runways for consolidation in both the retail automotive and heavy-truck dealerships remain long and organic growth should continue, with the firm one of the largest auto dealers in the US and UK. Our weighted average cost of capital is 8.4%.

Management has terminated the CarShop stand-alone used-vehicle brand in the UK (but not in the US) and rebranded the UK stores as Sytner Select, which we think may mean less capital investment over time. Sytner is a leading UK dealer group that Penske acquired in 2002. We model $300 million annually for share repurchases for most of our explicit forecast period. The company has cumulatively spent over $1.7 billion on buybacks across 2021-25, and we expect future spending to be more like these recent levels rather than lower levels before the pandemic.

We model total revenue for 2026-30 at about $177.1 billion, and total equity income over that period at about $1 billion. Our midcycle operating margin, including floorplan interest, remains 3.6%. We may raise this metric in the future to give the firm more credit for potentially scaling its overhead costs as it grows beyond traditional franchise light-vehicle dealerships via more heavy-truck dealers and growing its stand-alone used-vehicle store business, CarShop, Sytner Select, and in Australia, Penske Select. We believe digital initiatives create the opportunity for higher-than-historical-average profit metrics. Our midcycle margin reflects the possibility of margins ranging between below 2% in bad times to over 4% in good times.

We forecast revenue to increase by about 4.5% on a five-year compound annual growth rate basis, including the boost we expect from acquisitions. We model the operating margin, including floor-plan interest expense, to average about 3.4% during our five-year explicit forecast period. We also expect capital expenditures to average slightly under 1% of revenue per year.

About $53 of our fair value estimate is attributable to the equity income of the company's many equity method investments. These investments include a 28.9% stake in Penske Transportation Solutions, with another 41.1% owned by Penske Corp. and the final 30% by Penske Automotive shareholder Mitsui. PTS made up nearly all of Penske Automotive Group’s $192.9 million of 2025 equity income, and that year, PTS paid Penske Automotive cash distributions totaling nearly $98.7 million. The PTS distribution is paid quarterly. The other noteworthy equity investment is a 28% stake in Penske Commercial Leasing Australia. The latter rents heavy-duty commercial vehicles in Australia.

We continue to give the firm a narrow moat rating, as Penske's size continues to generate economies of scale and working capital efficiencies while the service segment's warranty work gives the company an intangible advantage over garages. A large dealer such as Penske can move inventory around to different stores where it will be in most demand, something a small dealer with just one or two stores in that same market cannot do. We think the dealer sector is the best business in the automotive supply chain. The public dealers can centralize back-office operations and generate far more volume than a small dealer, which brings scale. Dealers have no burdensome retiree expenses, and the large public dealers are not dependent on the health of one brand. The dealers enjoy mid- to high-single-digit gross margins on new vehicles and 100% gross margins on financing and insurance. We think the best source of competitive advantage is the parts and service operations. Many customers bring their vehicle to the dealer for servicing because either the vehicle is under warranty or the dealer is close to home and has the factory parts and expertise to service the vehicle. Once vehicle owners know a dealer, we think they are likely to keep going back to the dealer for service. The dealer knows the vehicle, and comparison-shopping for repair work is very time-consuming since the customer has to bring the vehicle to each shop to get a quote. These cost advantages and intangible advantages from service give dealers a moat.

These logistics create inelasticity of demand, which creates pricing power for the dealer and is a source of excellent profit in good times and bad. In fact, during a downturn in new-vehicle sales, dealers generally report higher gross margins due to a favorable mix shift to parts, but then report lower operating margins due to SG&A deleveraging. Excluding large impairment and restructuring charges, dealers can still report positive EBIT even in a severe recession. Although most dealerships are good businesses, we think the large publicly traded dealers are best positioned for growth since they can be the most flexible in changing brand mix and automakers prefer to give open points (new stores) to large dealers. Many small-business owners are choosing to exit or sell because they cannot get the scale on a variety of expenses compared with large dealer groups. Penske is one of the largest dealers in the US, yet we estimate it has only nearly 1% US new vehicle market share. About 91% of dealer owners own between one and five stores per the National Automobile Dealers Association, so we see a long growth runway for consolidators such as Penske.

Auto dealerships are stable, profitable businesses with a diversified stream of earnings coming from parts, service, and used cars.

Parts and service revenue should continue to be lucrative over time because most manufacturers require warranty work to be done at the dealership, and large dealers can more easily afford the technology and training needed to service increasingly more complex vehicles.

Penske is well suited to acquire dealerships because many small dealers do not want to keep paying expensive facility upgrades mandated by the automakers.

As publicly traded dealers command greater share in some markets, manufacturers may refuse to approve transfers of franchise rights at some dealerships, limiting acquisition-based growth.

New opportunities, such as Sytner Select in the UK and omnichannel, bring opportunities for growth but also more competitors.

Higher rent and a less lucrative mix of profitable financing commissions can cause Penske to incur more SG&A expenses as a percentage of gross profit than peers. However, when rent expense is excluded, the company's ratio is in line with the average for public dealerships.