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Morningstar | Expansion Into Used Vehicles and Trucking Should Continue for Penske

Penske Automotive Group receives 92% of its light-vehicle dealer revenue from import and luxury brands. This percentage is significantly higher than many dealers and helps mitigate the cyclical nature of auto sales; these brands have more-affluent customers who will not limit their discretionary spending as much as lower-income car buyers during a downturn. Despite this wealthy customer, the firm's operating margin tends to be on the lower end of the publicly traded dealers. The main reasons for this are that Penske gets less of its gross profit from higher-margin finance and insurance commissions than its peers, and selling, general, and administrative expenses (including rent expense) as a percentage of gross profit are higher than the other public dealers. Penske cannot get as much finance business--a 100% gross margin business--as its peers because more of its customers lease vehicles or pay cash.Most growth will come from acquisition because Penske is a rollup dealer. Penske has moved into heavy-truck distribution in Australia and New Zealand, truck dealers in the U.S. and Canada, and used-vehicle stores in the U.S. and U.K. The National Automobile Dealers Association reports that as of mid-2018, the number of new-car dealerships was 16,794, down from 25,025 in 1987. This highly fragmented industry has been consolidating because smaller players cannot compete with the scale and cost savings achieved through rollup acquisitions pursued by the six public franchise dealerships.Parts and service was only 10% of 2018 retail automotive revenue but made up 42% of gross profit. This significant contribution to profitability is less volatile than new- and used-vehicle sales and will continue to mitigate the cyclical risk of the auto industry. Large dealers are enjoying a growing competitive advantage for repair work because the increasingly advanced technology of cars presents an obstacle for smaller repair shops that are less able to afford the equipment and training needed to provide competent service. Consumers incur search costs (most notably time) to get many service estimates, which we think makes it more likely that they will keep going to the dealer.