Sonic Automotive Inc Q1 FY2024 Earnings Call

Good morning, and welcome to the Sonic Automotive First Quarter 2024 Earnings Conference Call. This conference call is being recorded today, Thursday, April 25, 2024. The 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 markets or otherwise make statements about the future. Such statements are forward-looking and are 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 very much, and good morning, everyone. Welcome to the Sonic Automotive First Quarter 2024 Earnings Call. I'm David Smith, the company's Chairman and CEO. Joining me on today's call is our President, Jeff Dyke; our CFO, Heath Byrd; our EchoPark Chief Operating Officer, Tim Keen; and our VP of Investor Relations, Danny Weiland. Earlier this morning, Sonic Automotive reported first quarter financial results, including total revenues of $3.4 billion, which was down 3% from the previous year. Our GAAP EPS for the first quarter was $1.20 per share, factoring in certain charges detailed in our press release this morning. Excluding these items, adjusted EPS was $1.36 per share, a 2% increase year-over-year, primarily due to our commitment to returning capital to stockholders through share repurchases and significant operational improvements at our EchoPark segment, which mitigated lower profits in our franchise dealership segment, showcasing the value of our diversified business model. We are proud of our team's performance in the first quarter and remain focused on adapting to changing market dynamics while positioning Sonic to achieve our long-term strategic goals. We strongly believe that our relationships with our teammates, manufacturer and lending partners, and guests are crucial to our success. I want to thank them all for their ongoing support. Now, turning to first quarter franchise dealership trends. We continue to see an expansion of new vehicle inventory levels across our brand portfolio, ending the quarter with a 50-day supply of inventory, which was up 37 days from the end of the fourth quarter. Consequently, same-store new vehicle gross profit per unit continued its sequential decline. We anticipate this decline in new vehicle gross profits to persist throughout 2024, exiting the fourth quarter in the low $3,000 range. However, we believe that the new normal level of new vehicle gross profit will remain structurally higher than it was before the pandemic. Additionally, our team is actively working with our manufacturer partners to align inventory levels and powertrain options with changing consumer demand. Recently, we have observed a rise in consumer demand for hybrid electric vehicles as a more cost-effective and convenient alternative to fully electric vehicles, allowing us to turn our hybrid inventory faster and achieve more traditional gross profit levels compared to fully electric vehicles. In the first quarter of 2024, fully electric vehicle sales reduced our reported new vehicle gross profit by about $400, consistent with the fourth quarter headwind due to price discounts to drive sales volume and manage EV inventory supply days. At the end of the first quarter, the average EV supply was 70 days, increasing our overall reported supply by 2 days, while hybrid vehicles averaged just 26 days supply. In the used vehicle market, wholesale auction prices for 3-year-old vehicles rose 2% during the first quarter, consistent with historical seasonal trends, while our franchise dealerships saw average retail used pricing decline 5% sequentially from the fourth quarter. Elevated used retail prices continue to challenge consumers, contributing to affordability concerns amid the current interest rate environment. Nevertheless, the return to normal seasonal trends in used vehicle wholesale pricing is promising for our business outlook and should enhance affordability and used vehicle sales volume for the remainder of 2024. Fewer lease turn-ins at our franchise dealerships limited our used vehicle volume in the first quarter, and lower used retail selling prices led to a 3% year-over-year decline in same-store used retail gross profit to $1,585 per unit. Our team remains dedicated to driving incremental used inventory acquisition and retail sales opportunities in 2024, fostering growth in this line of business alongside the expected normalization of used car pricing and volumes. Our finance and insurance performance remains a strong point despite elevated consumer interest rates, with same-store franchise finance and insurance gross profit of $2,350 in the first quarter, down 1% year-over-year but up 1% sequentially from the fourth quarter. Moreover, our franchise dealerships' finance and insurance penetration rates increased sequentially from the fourth quarter, illustrating our team's ability to navigate the high-interest-rate environment effectively. The sustained strength in finance and insurance performance supports our view that it will remain structurally higher than pre-pandemic levels, even in a challenging consumer affordability landscape. Our parts and service or fixed operations business continues to excel, achieving record quarterly fixed operations gross profit at our franchise dealerships, up 6% year-over-year on a same-store basis, driven by a 6% increase in our customer pay business and 13% growth in our warranty business. We are pleased with our team's success in this area and believe there are further opportunities to optimize our fixed operations business as we advance through 2024. As mentioned in our fourth quarter earnings call, we initiated a net 300 initiative to add 300 incremental technicians in 2024, which we expect will generate an additional $100 million in annualized fixed operations gross profit. Now, turning to the EchoPark segment. We are pleased to announce that EchoPark returned to positive segment adjusted EBITDA in the first quarter, reporting record quarterly adjusted EBITDA of $7.3 million, surpassing our target of breakeven adjusted EBITDA. Excluding closed stores, EchoPark segment adjusted EBITDA was $9.4 million in the first quarter, a significant improvement from a loss of $22.2 million last year on a same-market basis. For the first quarter, EchoPark revenues were $559 million, down 14% from the prior year, and gross profit was $52.6 million, up 34% from the previous year, despite a notable reduction in our store count year-over-year. EchoPark segment retail unit sales volume for the quarter was nearly 18,000 units, down 10% year-over-year. However, on a same-market basis, excluding closed stores, sales volume was up 13% in the first quarter. Revenue grew by 11% and gross profit increased by 79%. EchoPark's same-market total gross profit per unit was $3,018, reflecting a 65% year-over-year increase driven by marginal improvements in used vehicle market pricing, enhanced inventory sales velocity, and a 10% increase in finance and insurance gross profit per unit. As discussed in our previous earnings calls, the reductions in our store footprint since the first quarter of 2023 have allowed us to better distribute inventory across the platform, resulting in higher unit sales volume per location, improved variable gross profit, and a return to positive adjusted EBITDA. Our unwavering confidence in EchoPark's potential positions us as one of the few remaining nationwide used vehicle retailers, representing a significant long-term opportunity for this brand. The return to positive adjusted EBITDA for EchoPark validates the strategic adjustments we've made in recent quarters, and we are eager to pursue disciplined long-term growth as used vehicle market conditions continue to evolve positively in the coming years. Now, turning to our Power Sports segment. In the first quarter, we generated revenues of $27.7 million, with a gross profit of $7.8 million and a segment adjusted loss of about $800,000. Given the seasonal variability in the Power Sports industry and our presence in the Black Hills platform in Sturgis, South Dakota, our first quarter results were consistent with our projections. As we enter the Power Sports selling season in April, we will continue to focus on identifying operational synergies within our current Power Sports network and remain optimistic about future growth opportunities in this adjacent retail sector when the timing is appropriate. Finally, regarding our balance sheet, we concluded the first quarter with $847 million in available liquidity, which includes $335 million in combined cash and floor plan deposits. During the first quarter, we repurchased approximately 0.5 million shares of our common stock for $27 million. I am happy to report that our Board of Directors approved a quarterly cash dividend of $0.30 per share, which will be payable on July 15, 2024, to all stockholders of record on June 14, 2024. As indicated in the investor presentation released this morning, we are reaffirming our limited financial guidance for 2024 following the first quarter results. We maintain that lower earnings in the franchise dealership segment can be partially compensated by considerable improvements in our EchoPark segment results, which have returned to positive adjusted EBITDA for the year, alongside moderate increases in Power Sports segment income year-over-year. In conclusion, our team is committed to near-term execution and adapting to ongoing changes in the automotive retail landscape and macroeconomic environment while making strategic decisions to maximize long-term returns. Furthermore, we believe that our diversified business model offers significant earnings growth opportunities in both the EchoPark and Power Sports segments, helping to mitigate industry-driven margin pressures in the franchise business and reducing the potential earnings downside for our consolidated results. We are confident that we have the right strategy, the right team, and the right culture to continue growing our business and creating long-term value for our stockholders. This concludes our opening remarks, and we look forward to addressing any questions you may have. Thank you.

Our first question is from John Murphy with Bank of America.

Just a quick question on the statement you said about optimizing fixed ops. I understand the focus on hiring these 300 tech this year. I was wondering if you can give us an idea of the cadence and where you are on those, but if there's any other opportunities to optimize fixed ops? And ultimately, what do you think that drives besides those 300 techs that incremental profit you talked about, are there other opportunities above and beyond that?

John, it's Jeff. Yes. I mean, look, we're 35 to 40 incremental techs so far for the year. We expect to hit our 300 number, each of those techs generating $21,000 or so in gross per month per stall per day. So that's a huge opportunity for us. We have approximately 1,000 open bays across the organization. And you really run into a culture effect because technicians like to operate 2 bays. We're breaking that culture down. That's something that the industry deals with. We're breaking that culture down, and we've got stores out there that have a technician in them every day. It's something that we've really been focused on and will continue to focus throughout the rest of this year. So great opportunities to continue to grow in the mid- to upper mid-growth rate for the rest of this year. And I think into '25 and '26, the business is there, the customers are there. With the advent of EV and the opportunities that we have there, we see electric vehicles coming back more often than we do ICE. So I think there's plenty of opportunity. The thing is, we've got to break some culture down. We've got to work on that within the stores, our leadership team, and add those 300 techs, and then we'll focus next year on adding even more techs on top of that. So it's a big push for us. I think you're beginning to see some of those returns. Our fixed operations business is strong, and we expect that to continue.

Super helpful. Then just on EchoPark and used business in general. I mean we're girding to continued shrinkage of sort of 0 to 6 or 0 to 7 or even 0 to 4-year-old vehicles as we kind of grind through the pressed year from COVID new vehicle sales. I'm just curious how you are managing that, how much that constrains your ability to get EchoPark turned even more than you already have? And how you're going to deal with that? What does that mean for EchoPark?

Yes. I mean, look, we think that '24 is going to be a great year. I'm sure there are less lease returns with their calls and puts. There are cars coming in from rental car companies. There are delinquencies out there, and we're getting vehicles back that way. So there's plenty of inventory out there for us to buy. And remember, we're only buying for 18 stores right now. So we can very easily handle the amount of inventory we need for those 18 stores. We're going to be very smart about how we grow EchoPark. We will not open any more stores this year, and we'll look to that as we move into '25. We are not concerned at all about inventory in the 1- to 5-year-old category throughout this year to support our EchoPark stores. That's something that we're going to be able to easily do. And we'll continue to see the kind of returns that we got in the first quarter. I think in terms of cadence, the second quarter, the margins will be down a little bit. Third quarter should be strong, and fourth quarter might look a little bit like the second quarter. So it's going to be a great '24, and EchoPark is off to the races. We said that last year, we said, look, this is what it's going to take. There's new car inventories growing like crazy. You saw we went from a mid-30s day supply to a 50-day supply. I expect that to continue to grow. Manufacturers are building new cars left and right. That's just time and sense. It's going to put downward pressure on used vehicle pricing. It's going to allow us to buy more cars in the lanes; it's going to allow us to buy more cars from rental car companies. This is tailor-made for us. This is what we've been talking about. It's what we've been waiting for. Sure as that happened in the first quarter, and it's going to happen again throughout the rest of this year. It's going to be bumpy waters between now and probably the end of next year, but it's going to marginally get better as we go forward and '26 is off to the races as lease maturities begin to come back, and we are able to take advantage of those. The bad times for used vehicle inventory are behind us. That was the end of '22, beginning in '23; it's just not going to go back to that not with the way manufacturers are building new cars.

If I could add one more question. You mentioned that consumers are coming in asking for hybrids. Is that the case for all brands, or does that mainly indicate that hybrid inventories are returning this year? Are they increasing the number of hybrids available in the market? Is this trend specific to Toyota, or are you observing it across all the brands you represent?

It's industry-wide; if you see some of our other peer groups, they're saying the same thing. The consumer demand for hybrids is greater at the moment than EVs.

Yes. And it's a staircase to EV, right? And I think that's how you've got to look at it. Some of the hybrid vehicles that are coming now are just amazing; just back from the Mercedes meeting in Germany last week. Some amazing hybrid inventory is coming in '26. But it's across all brands, as David said, 100%.

Our next question is from Rajat Gupta with JPMorgan.

Congratulations on a strong quarter. I have a question regarding EchoPark. In the first quarter, the EBITDA was $7 million. You mentioned that there might be some reduction in the GPUs in the second quarter. I was wondering how we should view the total EBITDA growth throughout the year. Can you provide any additional details beyond the positive EBITDA mentioned in the slide deck? I also have a follow-up.

Yes. I mean, it's going to move around. The first quarter is always your strongest front-end margin quarter, seasonally adjusted, right? So if you just get rid of the last couple of years and go back to normalized sales, we always have the best margins in Q1. Q2 sinks a little bit as prices flatten out. I would expect certainly a positive EBITDA for the quarter, maybe not as strong as Q1. Then I expect Q3 to be really strong again, maybe like Q1 and then fourth quarter to look a little bit like Q2. So that's kind of how I'd look at it, a little up and down as we go through the year, but progressively, marginally getting better as we go into '25. I think '26 is just going to be a huge breakout year for EchoPark. So we're back; it's fun to be back and it's fun to put our inventory skill sets to work, and that's happening right now. And again, with 18 stores, it's not a problem. With 50 stores, maybe a little bit more of an issue because of the lack of total inventory out there. But there are fewer people that we're bidding against in the auction lanes, and that's where 80% of our inventory comes from because some didn't make it through all of this. We feel like we're some of the last ones standing on a national basis, and it's going to make it fun for us throughout the rest of this year and going forward.

It's important to emphasize what we're seeing from a demand standpoint. We've got some stores where we're needing to hire additional sales personnel; the demand is extremely strong. We have some stores that are selling over 30 cars per salesperson, which is fascinating. If you look at our reputation.com scores, virtually every review is a 5-star review.

That's key; David's point on having the right headcount and the right productivity per sales associate is part of the variability in EBITDA for the remainder of the year. How do we invest this positive EBITDA that we've flipped to in supporting ourselves for further growth? As we go through the year and into '25, with existing store base as pricing and affordability begin to improve, that should drive more volume, more potential there. We'll think about having the right headcount to support that growth, and there may be some investment ahead of the growth coming or on the brand marketing side of things. Having that optionality with positive EBITDA may let us begin to invest in and develop the EchoPark brand as we had intended to do a couple of years back and obviously had to make some adjustments on the fly, but continue to build that as we build out that national network over time.

That's helpful information. Regarding the broader used car market, I noticed positive comparisons in the franchise business. Although EchoPark is gaining some traction in volume, some of your competitors seem to still be under pressure with their same-store results. I'm interested in your perspective on what might be causing this difference. Is it partly due to the advantages of the franchise stores? Can you help me understand this disconnect? It seems like you're not experiencing any issues with the 1- to 5-year-old vehicles, so I'm curious about what is causing this divergence.

I can't speak for them. At the end of the day, I think we possess some of the best inventory management skill sets in the industry. We know where to get the cars, how to get the cars; and with inventory coming back on the new car side, it just opens the doors for us. I've read a lot of the commentary that are out there for the rest of this year. I know lease returns are going to drop off a cliff. But there are other ways to procure inventory. We just don't see it as having some massive effect on the used car business. We expect to grow our used car business from the low to mid-single-digit range for the year. I expect that to continue into the second, third, and fourth quarters and to grow from there. I can't explain some of the commentary. I sat with Tim Keen earlier this morning asking this exact question; I just don't get the commentary on the pre-owned inventory. The bad days are behind us. They're not in front of us. There's inventory out there to procure. We're seeing that. I expect us to continue to grow with good margins throughout the rest of this year. It's not going to be gangbusters or significantly marginally better, but marginally better throughout this year.

Our next question is from Bret Jordan with Jefferies.

This is Patrick Buckley on for Bret. On the new GPU side, with the estimated '24 exit range of about $3,000, should we expect a pretty steady progression throughout the year? And I guess into '25, how does that compare to what you guys expect the new normal to be?

Yes. So it's Jeff. I think between $200 and $250 a quarter reduction as we move forward, getting us into that exiting '24 in the $3,000 range. I think it's going to kind of hang there. There is a new normal for front-end margin. I don't expect the manufacturers to just continue to go crazy on new car production, although EVs are going to play a role in all this. But I'm quite confident that in and around that $3,000 range exiting this year, we'll be there and then I expect it to be in and around that range for '25 as well.

That's helpful. And I guess on that note, were there any notable callouts from a brand or region mix within new GPUs this quarter?

No. EVs continue to be a little bit of a drag. As we announced in David's opening comments, that's about a $400 drag on the overall GPU, and that's being driven by a handful of brands. Our days supply on EV is fine. You really can't look at the day supply overall numbers. You got to look at the actual units. We have a 60-day supply of BMW EVs on the ground, but it's at 600 units, and they're cutting back significantly on EV production and coming more with hybrids. I think the manufacturers recognize that they're doing the right things. I think that stabilizes everything as we move forward.

There are no further questions at this time. I'd like to hand the floor back over to David Smith for any closing comments.

Thank you very much, and thank you, everyone, for joining us, and we'll talk to you next quarter. Thanks a lot.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.