Courtesy of www.fastgraphs.com.
If we told you about a company that saw earnings per share drop by nearly half – from $1.49 a share to $0.86 – during the recession, what would you think? Before you answer, it’s important to also point out that the company suspended its dividend from late 2008 until early 2011 as well. At first blush this might seem like a worst case scenario. Usually we go about our research time looking for the best companies that have held up even in the worst of times – this type of company does not fit the bill. Yet what is not readily obvious is the fact this would have been the best time to buy.
As one might have guessed from the article’s title, the company to which we are referring is Michigan-based Penske Automotive Group (PAG). Penske is an international transportation services company, operating retail automotive dealerships, Hertz car rental franchises and commercial vehicle distribution. Employing about 17,000 people worldwide, Penske Automotive Group does about two-thirds of its business in the U.S. and just under a third in the U.K. – with the BMW, Audi and Mercedes-Benz brands making up roughly half of the company’s total sales. However, that is not to say that Penske Automotive Group is without diversification in automotive brands. The company also sells under brand names ranging from Honda, Nissan and Toyota to Jaguar, Ferrari and Porsche.
As we will later see, Penske Automotive Group has grown operating earnings by 11.9% over the last decade and a half. However, over the last five years – coming out of the recession – the business has grown by just over 20% a year. In addition, the dividend has been reinstated and the P/E ratio jumped from a low around 7 to today’s more normal 15. If you take all of these items collectively, it translates to some especially spectacular results. If one had bought shares of Penske Automotive Group at the end of 2008 and held until today, your total return would have come in at an annualized rate of 40.6% against an also impressive market average of 16.1%. Interestingly, despite not paying a dividend for a good portion of this time period, one would still have received more income than the S&P 500 index as well.
Looking forward it’s highly unlikely that this company’s performance results will come anything close to the last five years – the “perfect storm” of low valuation and strong business operations is a rare combination. However, it is noteworthy to indicate that the best time to partner with a company is often when the prospects look the worst. Today Penske’s prospects look much better, but the investment rationale still appears reasonable.
For instance, much of the company’s revenue is generated from import and luxury brand names whose clientele is usually more affluent. As a result, these customers might not have to curb their spending as much during mild downturns. If you believe in sustained economic growth moving forward, this customer stickiness might be rewarded. Much in the same way that management believes they can create certain stickiness for customers who get their car repaired at the dealership.
Or perhaps you believe the recent acquisition of an Australian Commercial Vehicle Group will prove to be a worthwhile growth avenue. Management pegs the additional impact to be accretive by about $0.10 to $0.14 per share on an annualized basis. Conceivably, Penske can continue to make strategic acquisitions.
Finally, despite the dividend suspension in 2008, Penske has done of excellent job of restoring faith in this payout. Since May of 2011, the company not only reinstated the payout, but has also increased it every single quarter since. The most recent 6.3% increase while still only paying out about a fourth of profits bodes well for future increases. With the above points demonstrated, let’s take a longer look at the past operating results of the company through the powerful Fundamentals Analyzer Software Tool of F.A.S.T. Graphs.
15 Years of Growth
Penske Automotive Group has grown earnings (orange line) at a compound rate of 11.9% since 1999, resulting in a 3.5+ billion dollar market cap. In addition, Penske Automotive Group’s earnings have risen from $0.55 per share in 1999, to today’s forecasted earnings per share of approximately $2.71 for 2013. Further, as described, Penske reinitiated its dividend (pink line) in 2011 and has been able to increase this payout every single quarter since.
For a look at how the market has historically valued Penske Automotive Group, see the relationship between the price (black line) and earnings of the company as seen on the Earnings and Price Correlated F.A.S.T. Graph™ below.
Here we see that Penske’s market price previously began to deviate from its justified earnings growth; starting to become undervalued during the most recent recession and coming back to fair value as of late. Today, Penske Automotive Group appears in-value in relation to both its historical earnings and relative valuation.
In tandem with the strong earnings growth, Penske Automotive Group shareholders have enjoyed a compound annual return of 16% which is even better than the company’s 11.9% growth rate in earnings per share. A hypothetical $10,000 investment in Penske Automotive Group on 12/31/1998 would have grown to a total value of $90,513.46, without reinvesting dividends. Said differently, Penske Automotive Group shareholders have enjoyed total returns that were roughly 5.3 times the value that would have been achieved by investing in the S&P 500 over the same time period. It’s also interesting to note that an investor would have received approximately 2.1 times the amount of dividend income as the index as well.
But of course – as the saying goes – past performance does not guarantee future results. Thus, while a strong operating history provides a fundamental platform for evaluating a company, it does not by itself indicate a buy or sell decision. Instead, an investor must have an understanding of the past while simultaneously thinking the investment through to its logical, if not understated, conclusion.
In the opening paragraphs potential catalysts were described. It follows that the probabilities of these outcomes should be the guide for one’s investment focus. Yet it is still useful to determine whether or not your predictions seem reasonable.
Thirteen leading analysts reporting to Standard & Poor’s Capital IQ come to a consensus 5-year annual estimated return grow rate for Penske Automotive Group of 14.5%. In addition, PAG is currently trading at a P/E of 14.7, which is inside the “value corridor” (defined by the orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Penske’s valuation would be $81.21 at the end of 2018, which would be a 16.9% annualized rate of return including dividends. A graphical representation of this calculation can be seen in the Estimated Earnings and Return Calculator below.
Now, it’s paramount to remember that this is simply a calculator. Specifically, the estimated total return is a default based on the consensus of the analysts following the stock. The consensus includes the long-term growth rate along with specific earnings estimates for the next two upcoming years. Further, the dividend payout ratio is presumed to stay the same and grow with earnings. Taken collectively, this graph provides a very strong baseline for how analysts are presently viewing this company. However, a F.A.S.T. Graphs’ subscriber is also able to change these estimates to fit their own thesis or scenario analysis.
Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk treasury bonds. Comparing an investment in Penske Automotive Group to an equal investment in a 10-year treasury bond, illustrates that Penske’s expected earnings would be 5.3 times that of the 10-year T-Bond Interest. This comparison can be seen in the 10-year Earnings Yield Estimate table below.
Finally, it’s important to underscore the idea that all companies derive their underlying value from the cash flows (earnings) that they are capable of generating for their owners. Therefore, it should be the expectation of a prudent investor that – in the long-run – the likely future earnings of a company justify the price you pay. Fundamentally, this means appropriately addressing these two questions: “in what should I invest?” and “at what time?” In viewing the past history and future prospects of Penske Automotive Group we have learned that it appears to be a strong company with reasonable upcoming opportunities. However, as always, we recommend that the reader conduct his or her own thorough due diligence.
Disclosure: No position at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
