Sonic Automotive Inc Q4 FY2023 Earnings Call

Greetings, and welcome to the Sonic Automotive Fourth Quarter 2023 Earnings Conference Call. This conference call is being recorded today, Wednesday, February 14, 2024. Presentation materials which accompany management's discussion on the conference call can be accessed at the company's website at ir.sonicautomotive.com. At this time, I would like to refer to the Safe Harbor Statement under the Private Securities and Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information, or expectations about the company's products or market, or otherwise make statements about the future. Such statements are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. These risks and uncertainties are detailed in the company's filings with the Securities and Exchange Commission. In addition, management may discuss certain non-GAAP financial measures as defined by the Securities and Exchange Commission. Please refer to the non-GAAP reconciliation tables in the company's current report on Form 8-K filed with the Securities and Exchange Commission earlier today. I would now like to introduce Mr. David Smith, Chairman and Chief Executive Officer of Sonic Automotive. Mr. Smith, you may begin your conference.

Thank you, and good morning, everyone, and welcome to the Sonic Automotive fourth quarter 2023 earnings call. Joining me today are our President, Jeff Dyke; our CFO, Heath Byrd; our EchoPark Chief Operating Officer, Tim Keen; and our VP of Investor Relations, Danny Wieland. Earlier this morning, Sonic Automotive reported fourth quarter and full-year financial results, including fourth quarter total revenues of $3.6 billion and all-time record annual revenues of $14.4 billion, up 3% from the previous year. Fourth quarter GAAP EPS was $1.11 per share, which includes the effect of non-cash impairment charges and tax items. Excluding these items, adjusted EPS was $1.63 per share, a decrease from $2.61 in the prior year due primarily to continued normalization of new vehicle GPU and higher interest rates. We are very proud of our team's performance in the fourth quarter and we remain focused on leveraging our diversified business model to adapt to changing market dynamics in the near term while positioning Sonic to achieve our long-term strategic goals. We believe our strong relationships with our teammates, manufacturer and lending partners and guests are key to our future success. I'd like to thank them all for their continued support. Turning now to fourth quarter franchise dealership trends. We continue to see expansion of new vehicle inventory levels across our brand portfolio, ending the year with a 37 days’ supply of inventory, up from 33 days at the end of the third quarter and 24 days at the end of 2022. As a result, new vehicle gross profit per unit continued its sequential decline to $4,289 per unit in the fourth quarter, in line with our previous guidance to exit 2023 in the low to mid $4,000 range. This steady decline in new vehicle GPUs should continue throughout 2024, but we continue to believe that the new normal level of new vehicle GPU will remain structurally higher than it was pre-pandemic historically in the $2,000 per unit range. Furthermore, our luxury-weighted portfolio generally runs a lower inventory day supply and our luxury manufacturer partners have more effectively balanced supply to date, potentially minimizing new GPU compression relative to overall industry trends, which would continue to benefit the earnings power of our franchise business. In the used vehicle market, wholesale auction prices for three-year-old vehicles decreased nearly 9% in the fourth quarter, while average retail used pricing declined just 2%. Elevated used retail prices remain a challenge for consumers, contributing to affordability concerns amid the current interest rate environment. However, the downward trends we are seeing in used vehicle wholesale pricing are positive for our business outlook and should benefit affordability and used vehicle sales volume in 2024. Fewer lease turn-ins at our franchise dealerships continued to limit our used vehicle volume in the fourth quarter, and used market seasonality drove a decline in used retail GPU to $1,443 per unit on a same-store basis. Our team remains focused on driving incremental used inventory acquisition and retail sales opportunities in 2024, driving upside in this line of business alongside the expected normalization of used car pricing and volumes over time. Despite an elevated consumer interest rate environment, our F&I performance continues to be a strength with same-store franchised F&I per unit of $2,334 in the fourth quarter. Our franchise dealership F&I penetration rates were stable quarter-to-quarter and we achieved our previously issued guidance for full-year 2023 franchised F&I GPU at or above $2,400 per unit with same-store franchised F&I GPU of $2,411 for the full-year. For comparison, for full-year 2019, our franchised F&I GPU was $1,620, which was nearly $800 lower than the current run rate and we expect to see continued stability in F&I GPU in 2024. Our parts and service or fixed operations business remains strong with record fourth quarter fixed operations gross profit at our franchise dealerships up 7% year-over-year on a same-store basis, driven by 9% growth in our customer pay business. We are proud of the success our team has had in this area and we believe there are remaining opportunities to optimize our Fixed Ops business as we progress through 2024. Turning now to the EchoPark segment. For the fourth quarter, we reported EchoPark revenues of $557 million, down 6% from the prior year, and record fourth quarter EchoPark gross profit of $43 million, up 5% from the prior year, despite a significant reduction in our store count year-over-year. EchoPark segment retail unit sales volume for the quarter was nearly 17,600 units, up 1% year-over-year. However, on a same-store basis, EchoPark retail unit sales volume was up 42% in the fourth quarter. Third quarter EchoPark segment adjusted EBITDA was a loss of $9.1 million compared to an adjusted EBITDA loss of $25.4 million in the fourth quarter last year. In January 2024, we made the difficult decision to close the seven remaining Northwest Motorsport preowned stores in the EchoPark segment due to unique ongoing challenges to the Northwest Motorsport business model. This decision, while not taken lightly, was made in order to benefit EchoPark's near-term profitability path and better align with our overall used vehicle strategy. Fourth quarter adjusted EBITDA loss associated with the Northwest Motorsport Group totaled $1.3 million. That's $1.3 million, while full-year adjusted EBITDA losses associated with the group totaled $5.1 million. Moving forward, we remain confident in our path to achieve breakeven EchoPark segment adjusted EBITDA in the first quarter of 2024 and positive EchoPark segment adjusted EBITDA for the full-year. Sonic's diversified cash flows and strong balance sheet allowed us to withstand the challenges in the used vehicle market over the last three years and maintain our long-term EchoPark plans. Our unwavering confidence in EchoPark's future potential has positioned us as one of the few remaining nationwide used vehicle retailers, creating a tremendous opportunity for this brand down the road. We look forward to resuming disciplined long-term growth for EchoPark as used vehicle market conditions improve. Turning now to our Powersports segment. For the fourth quarter, we generated revenues of $27 million, gross profit of $7 million, and an adjusted EBITDA loss of $2.4 million. Given the seasonal variability in the Powersports industry and our geographic presence with the Black Hills platform, our fourth quarter results were in line with our projections. Looking into 2024, we continue to focus on identifying operational synergies within our current powersports network and remain optimistic about the future growth opportunities in this adjacent retail sector when the time is right. Finally, turning to our balance sheet. We ended the third quarter with $846 million in available liquidity, including $374 million in combined cash and floor plan deposits on hand. The strength of our balance sheet allowed us to repurchase 3.3 million shares of our common stock in 2023, or 9% of shares outstanding at the beginning of the year. At the end of the fourth quarter, our remaining share repurchase authorization was $287 million, which represents approximately 15% of today's equity market cap. Share repurchases are an important part of our capital allocation strategy, and we remain focused on returning capital to shareholders via share repurchases as our liquidity and other capital needs allow. Additionally, I'm pleased to report that our Board of Directors approved a quarterly cash dividend of $0.30 per share, payable on April 15, 2024, to all stockholders of record on March 15, 2024. As we move ahead to 2024, I'd like to call your attention to Pages 12 and 13 in the investor presentation we released this morning, where we discuss our outlook for the industry in 2024 and provide limited financial guidance for certain metrics. From a consolidated company earnings perspective, we expect lower franchise dealership segment earnings to be partially offset by significant improvement in EchoPark segment results, returning to positive adjusted EBITDA for the year, as well as a moderate increase in Powersports segment income year-over-year. While the financial outlook in the investor presentation is subject to inherent forecast risks and uncertainties, some of which are beyond our control, we believe the metrics provided may be useful in developing a financial model for Sonic's 2024 results. In closing, our team remains focused on near-term execution and adapting to ongoing changes in the automotive retail environment and macroeconomic backdrop, while making strategic decisions to maximize long-term returns. Furthermore, we continue to believe that our diversified business model provides significant earnings growth opportunities in our EchoPark and Powersports segments that may help to offset any industry-driven margin headwinds we may face in the franchise business, minimizing the earnings downside to consolidated Sonic results over time. We remain confident that we have the right strategy, the right people, and the right culture to continue to grow our business and create long-term value for our stakeholders. This concludes our opening remarks and we look forward to answering any questions you may have. Thank you very much.

Thank you. We will now open the floor for questions. Our first question comes from Daniel Imbro with Stephens. Please go ahead with your inquiry.

Hey, guys. This is Joe Enderlin on for Daniel. Thanks for taking the questions.

Good morning, Joe.

Good morning. On the franchise side, your SG&A assumption of low-70s margin was a little higher than we expected. Could you maybe bucket out what drives these costs higher? And maybe is this where you expect long-term margin to shake out? Or do you expect leverage after 2024 and we return to a more normal GPU guidance? Thanks.

Yes. Hey. This is Heath Byrd. A couple of things. Obviously, SG&A as a percent of gross is heavily dependent on gross, right? And in our guidance of a low 70% range, we also have about $1,200 degradation in the front-end GPU. You just take that degradation on a flat unit basis, that's $130 million of gross. That's leading the numerator in that calculation. We do have about a 1% increase in units in there that does offset some of that loss in gross. And so the biggest component is that $130 million give or take decrease in gross. If you look at the expenses, the variable expenses are leveraging as they should as gross is going down. Fixed expenses, there are some that are higher than normal, insurance coverage, trying to get coverage with property and casualty is going up across the country. Also, loan expense is higher because our Fixed Ops business is growing at such a good pace. And we have manufacturer requirements to use EVs as loaners. And the depreciation of those are higher than ICE vehicles. And so that impacts our loaner expense. And some IT expenses and investments for future optimization. There's definitely upside potential in that SG&A gross. The GPU degradation may be slower than we expected, but I think it's pretty standard across the peer group that in that range of about 1,200 loss for the year. Our portfolio could outperform the SAR. The expectations out there are from 1% to 4%. We have a low single-digit expectation in the units that we sell. And obviously, we've got potential in the F&I and fixed gross to offset that loss in new gross. We also have plans to have some structural changes in our expense structure, which could also impact that number. So we definitely see an opportunity to beat that number, but looking at the math and the things that we see out there, we think a low 70% range is appropriate.

Got it. That's helpful. As a follow-up, just given the weakness in the used market as a whole, do you have any updated thoughts on what gives you confidence in the long-term operating model of EchoPark? Do you maybe increasingly think that consolidation of assets is going to play a considerable role in returning to that peak profitability?

Yeah. This is Jeff. Certainly, the reduction in store count has helped us and our buying team buy cars for fewer stores, and that's proving out in the numbers as we called out in the second quarter and the third quarter. We're seeing excellent growth across the remaining 18 stores that we have. And with the manufacturers putting more and more inventory out on the street, it's going to just naturally, common sense, it's going to drop pricing. We're seeing that. Average wholesale prices are dropping. We're buying cars now in the mid-23 range. I expect that to continue to drop, in particular, after we get out of the March or kind of April selling timeframe. And that'll continue to improve as we move throughout the year. With that, we're going to sell more cars. We're gaining confidence with where we were with EchoPark back in 2019. And then we can start looking at strategic growth for EchoPark, being very conservative, but getting back on the bicycle and growing the brand again. And so we've just been waiting. Certainly, as we called out in the third quarter, turbulent waters for the used car business. We think there's another 16 months, 18 months of that, but progressively getting better as we move throughout the year.

Got it. Thank you, guys. That's all for us.

Thank you.

Thank you.

Thank you. Our next question comes from the line of John Murphy with Bank of America. Please proceed with your questions.

Good morning, everyone. I wanted to follow up on that previous question. Jeff, it seems that demand for vehicles is gradually improving. I'm curious about the dynamics between the used and new markets. Are we seeing a trend where consumers are shifting more towards buying new vehicles instead of used ones? Additionally, there's the issue of the decreasing inventory of one to six-year-old used cars. There are many factors at play here. We're hearing mixed signals regarding the used market being weak, but this doesn't seem to align with the notion that vehicle demand is on the rise. Could you provide more insights on this, particularly regarding the new stores and EchoPark?

I don't agree with the idea that the used vehicle market is weakening. In fact, it's stabilizing and starting to improve. As we look ahead, with the number of new cars manufacturers are releasing, we're going to trade for more vehicles, particularly one to five-year-old cars. This is positively impacting both our franchised used vehicle departments and EchoPark. The data supports this; our EchoPark volume is significantly increasing. We are now selling more cars from 18 stores than we previously sold from 45 stores. We anticipate this trend will continue. I believe the used vehicle market will strengthen as the year progresses because wholesale prices are expected to decline. This decline is mainly due to manufacturers increasing the number of cars on the road, although there's variability in how well they're managing this. Additionally, the introduction of electric vehicles will play a role, especially as we move into mid-summer and more off-lease cars become available. I see nothing but positive developments for the used vehicle sector, which is why we are optimistic about achieving breakeven EBITDA for EchoPark in the first quarter. We are well-positioned for the year ahead. The used car market has always been robust, but we have faced shortages of one to five-year-old models for EchoPark, causing some challenges in recent years. That issue is resolving, and as we progress through 2024, we expect continued strength, which will be beneficial for the EchoPark model. This creates a balance against our franchise operations, and we anticipate an outstanding year for EchoPark.

That's very helpful. I have a follow-up regarding the F&I PVR of approximately $2,400 that you are targeting. It appears that we have navigated through the most challenging period regarding rising rates and their associated negative impacts. While there may be a slight decrease in revenue per unit or ATP in 2024, is there a possibility for significant growth in that area in 2024 or potentially over time as you improve the penetration of some of the valuable products you've developed along with those from the industry?

Absolutely. As we progress into the second half of the year, we expect rates to decrease slightly. With retail pricing falling, there is a reduction in margin related to finance and insurance. However, we see significant potential for growth. We typically rank among the top in our category, and we believe we can achieve a finance and insurance per vehicle retail level similar to or exceeding AutoNation's performance. Our EchoPark stores are already reaching that level or higher, and we anticipate seeing improvements in front-end margins at EchoPark as we move through the first quarter and into the remainder of the year. Therefore, we view this as a positive signal, and we see opportunities for enhancement in finance and insurance as we advance.

Thank you very much, guys.

Thank you.

Thank you. Our next question comes from the line of Rajat Gupta with JPMorgan. Please proceed with your question.

Great. Thanks for taking the questions. I just wanted to, first reconcile, some of the comments on the used car market. I think Jeff, I think earlier in the call, you mentioned that the backdrop is likely to remain tough for 16 months to 18 months. But then to John's question earlier, I think you mentioned that you're seeing improvement. I'm just curious like, how should we reconcile those comments? And then would you be able to put a finer point on expectations for used car volumes, both at EchoPark and the franchise business for 2024? And I have a quick follow-up on SG&A. Thanks.

I believe that over the next 16 to 18 months, we won't reach the levels seen in 2019, but there will be steady improvement. For EchoPark, I anticipate volume to be similar to last year's, despite having fewer stores for half the year. We're also forecasting low single-digit growth in used car volume on the franchise side. While we’re still facing challenges, the situation is much more stable than it was. With wholesale market prices decreasing, we expect gradual improvement throughout 2024 and into early 2025. We feel confident about EchoPark and our current position. We communicated this in the second quarter, took necessary actions, and observed the effects in the third and fourth quarters. This positive trend has continued into January and February, and we expect the rest of the year to show further improvement as we progress.

Got it. That's very clear. Thanks for taking the questions.

Thank you.

Thank you. Our next question comes from the line of Glenn Chin with Seaport Research Partners. Please proceed with your questions.

Good morning. Thanks, gentlemen.

Good morning.

Just circling back to your comments about GPU headwind from EVs. Is that a...

We lost you.

Sorry, can you hear me?

We can. Ask that again.

Sorry about that. Just circling out to your comment, Jeff, about GPU headwind from EVs at $400. That's a comment relative to year-over-year, correct, not sequential?

That's the headwind in the fourth quarter. So if you look at our blended GPU that we reported for Q4, it reflects a $400 headwind from EV GPUs, running at a lower rate than the remainder of the business.

And, and in some brands, negative margin and significant negative margin, which added, which added to that.

Okay. Very good. And then, historically, fourth quarter is seasonally strongest for earnings for Sonic. Can you just highlight the factor or factors that primarily drove that disruption to that trend this year?

I mean a lot of us, this is David. We've talked a lot about it, right? There was a window of uncertainty that really impacted our traffic. I think the overall macroeconomic landscape made people hesitant to do business for a while, and then it began to improve in some areas towards the end of the year. But again, that's a macro point of saying, hey, we'll just wait and see if this storm clears a bit before we go back, and that's some of the feedback we've received.

Okay.

So the other thing that I would add to that is BMW plays an enormous role in our overall performance. And our growth on BMW in the quarter was about 1.1%. You compare that to some of our other High Line manufacturers. Lexus were up 76% in the quarter. Audi up almost 23%. Luxury was up 11.4%. But when BMW doesn't have the kind of volume in the quarter that it normally would have, that and the gross erosion associated with that, that certainly did not help during the quarter. And that was really driven by inventory levels. BMW has done an amazing job overall, keeping their days’ supply down, and did that during the fourth quarter. We missed out on some opportunities there. And because we have so many BMW stores, and they're such a big part of our overall revenue mix, that certainly played a role in the overall performance in the quarter.

Okay. I apologize. I hopped on late, so thank you for clarifying.

Okay.

And then just on your outlook. Thank you for the comprehensive look. That's very helpful. I don't suppose you guys would care to venture a range for a potential adjusted EBITDA profitability for EchoPark for 2024?

No. We do have that we forecast being positive EBITDA for the year, but I go far and that's as far as we go.

Okay. And can I ask just what that, what that may be predicated upon? Does it require any more store closures? Or is the footprint you guys have now set?

That's, that's not something we built into it. Is it an additional store closures?

Yeah. I mean, look, the used vehicle business is getting better. The inventory supply is getting better. The average wholesale price is dropping significantly. And when you combine all of those things, that's why we just have such confidence in our EchoPark model and why we stuck it out through those last three very difficult years. It makes for a pretty picture for '24 and even better as the years go on. We're coming out of those turbulent waters, as I said earlier. And it's going to make for a fun year. EchoPark is going to have a great year, and we're very excited about being back on our bicycle, so to speak, and getting, getting those stores back to selling the kind of volume that we built them for and driving the kind of growth that we built them for. And that's upon us now. We've waited a long time, worked really, really hard. Our team has busted their butts to get through all of this, and we're getting ready to enjoy the rewards from the hard work that went into that.

I went into. David, as I mentioned, our opening comments, talking about our diversified business model and being able to weather the storm, we view it, and jokingly here in the office, talk about it's like in the movie Forrest Gump when they survived the storm.

As I mentioned earlier, we're discussing our diversified business model and its ability to withstand challenges. We often jokingly compare it to the movie Forrest Gump, where they survived the storm. We've observed other competitors shutting down, but we believe the used vehicle market has not permanently diminished. In fact, we think it will emerge stronger. This market has historically been much larger than the new vehicle market, and we see significant opportunities for EchoPark moving forward.

Yeah. And one more point to add, this is Danny. Glenn, I think you mentioned in your note this morning that even just going from the $83 million adjusted EBITDA loss at EchoPark in 2023 to zero results in over $1.50 of EPS benefit. And we've indicated that we expect to be positive for the full year next year. So there's a significant opportunity to offset at least somewhat the ongoing normalization of franchised earnings just by getting back to zero, not to mention achieving positive EBITDA on the EchoPark segment.

Yeah. Understood. Okay. Thanks. And then just last for me. If you can just comment on the spread between wholesale and retail used pricing, has it normalized and what you guys might see doing for the rest of this year?

No, it's not normalized. I think wholesale prices in the fourth quarter dropped like 9%. Retail dropped 2%. And as you know, there's a seven, eight week lag there. There's still a lot of high percentage of no sales in the auction lanes, I think that's running north of 40%, but down from 50%. And so everybody is still trying to find their way through this, the back edges of the storm. But we expect those two things to catch up with each other as we move into March and April and May. And again, put some wind in the sails of EchoPark and the industry. Used vehicle business should be getting better, as we move forward.

So in other words, yes, so, so that spread should be widening, correct?

Yes, that's exactly right.

Yeah. Okay. Very good. Thanks for all the comments.

Thank you. Appreciate the questions.

Thank you. There are no further questions at this time. I'd now like to hand the call back over to David Smith for any closing remarks.

Thank you very much, and thank you, everyone, for participating in the call, and we look forward to speaking with you our next quarter. Thank you.

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.