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Morningstar | Group 1's 1Q Boosted by Improved Used and Parts Performance

Group 1's first quarter had good results overall, and we don't see a reason to change our fair value estimate. Adjusted diluted EPS of $2.06 easily beat consensus of $1.83, and total revenue fell 1.8% to roughly match consensus. On a constant-currency basis, revenue increased 0.3%. Revenue mix from the United Kingdom, 22.9% of revenue, was the main currency headwind, but the weak Brazilian real against the dollar also played a role.

Group 1’s decision to move its service technicians to a four-day workweek looks like a smart move. Technicians are hard to find in the auto industry, a problem that will only get worse, and Group 1's technician headcount rose 15% year over year. This personnel retention move is a win-win for customers and the firm, since Group 1 can do more jobs while not spending more money to expand service bay capacity. Parts and service is extremely profitable and made up 46% of total gross profit in the quarter, so any material improvements to the segment are likely to continue into 2019. The higher flow-through from parts and an impressive 14.3% rise in U.S. used-vehicle gross profit helped Group 1 better leverage its selling, general, and administrative expenses and increase adjusted operating margin by 30 basis points to 3.1%. Adjusted SG&A as a percentage of gross profit declined by 120 basis points to 76.1%.

U.S. operations suffered no headwinds in any one geographic market, and higher oil prices could actually help results later this year since Texas and Oklahoma constitute about 40% of new-vehicle unit volume. The U.K. took a hit on the new-vehicle side as Audi inventory shortages from noncompliance of new European emission rules continued, but we expect those problems to resolve themselves as soon as the second quarter. Brazil's adjusted pretax margin of 0.1% reflected the company not taking on more Honda inventory there to rightsize inventory and the first quarter is the segment's weakest, so we expect sequential improvement this year.

The company is also expanding its U.S. online retailing program to about 60 stores later this year. We think this is the right move because as CEO Earl Hesterberg said on the call, a retailer has to be able to do business when and how the customer wants to. The digital platform includes home delivery as an option, and consumers can seek financing and get their trade-in appraised. We are not surprised that management said on the call that digital customers tend to be much more likely to complete a sale once they "get into the funnel" compared with traditional customers. We think consumers enjoy the flexible experience of doing some purchase tasks online and others at a store, plus we think once shoppers invest more time at one retailer, they are more likely to finish the vehicle purchase with that retailer than start all over somewhere else.