Penske Automotive Group, Inc. (PAG) on Q3 2021 Results - Earnings Call Transcript
Operator: Good afternoon, ladies and gentlemen. Welcome to the Penske Automotive Group Third Quarter 2021 Earnings Conference Call. Today's call is being recorded and will be available for replay approximately 1 hour after completion through November 3, 2021, on the company's website under the Investors tab at www.penskeautomotive.com. I will now introduce Anthony Pordon, the company's Executive Vice President of Investor Relations and Corporate Development. Sir, please go ahead.
Anthony Pordon: Thank you, Jerome. Good afternoon, everyone, and thank you for joining us again today. A press release detailing Penske Automotive Group's record third quarter 2021 financial results was issued this morning and is posted on our website along with the presentation designed to assist you in understanding the company's results. As always, I'm available by e-mail or phone for any follow-up questions that you may have. Joining me for today's call are Roger Penske, our Chair and CEO; and Shelley Hulgrave, our Chief Financial Officer; and Tony Facioni, our Vice President and Corporate Controller. Our discussion today may include forward-looking statements about our operations, earnings potential, outlook, future events, growth plans, liquidity and assessment of business conditions. We may also discuss certain non-GAAP financial measures, such as earnings before interest, taxes, depreciation and amortization or EBITDA. We have prominently presented the comparable GAAP measures and have reconciled the non-GAAP measures in this morning's press release and investor presentation, which are available on our website to the most directly comparable GAAP measures. Our actual results may vary because of risks and uncertainties outlined in today's press release, which may cause the actual results to differ materially from expectations. I direct you to our SEC filings, including our Form 10-K, for additional discussion and factors that could cause results to differ materially. I will now turn the call over to Roger Penske.
Roger Penske: All right. Thank you, Tony. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report all-time record third quarter results for PAG, including the best quarter in the history of the company. Our total revenue increased 9% to $6.5 billion and income from continuing operations before taxes increased 53% to $476 million, and income from continuing operations increased 44% to $355 million and related earnings per share increased 45% to $4.46. Although unit sales were impacted by supply shortages in both our retail automotive and commercial truck dealership operations, earnings growth was driven by a 39% increase in retail automotive and 135% increase in commercial trucks, gross profit per unit retailed, also a 4% increase in retail automotive service and parts gross profit and a 230 basis point reduction in SG&A to gross profit and $15 million in lower interest costs, coupled with an increase in commercial truck dealership EBT of 106% and an 83% increase in earnings from Penske Transportation Solutions. This demonstrated the continued strength of our investment and the benefit provided by our diversified business model. Looking at our retail automotive operations on a same-store basis for Q3 '21 versus Q3 '20, units declined 8%; however, revenue increased 7%. Gross profit increased 18%, including 180 basis point increase in our gross margin. Our variable gross profit increased 39% to $5,769 per unit compared to $4,152 last year. Looking at CarShop, we now operate 22 locations and expect to open 1 additional location by the end of the year. We recently added locations in Leighton Buzzard and Wolverhampton in the U.K. and our Scottsdale location opened this week. During the quarter, CarShop unit sales increased approximately 1% to 18,451 units. Revenue improved 24% to $438 million and gross profit per unit increased 12% to $2,668. Our current annualized run rate is approximately 70,000 to 75,000 units, representing revenue of $1.6 billion and an EBT between $45 million and $50 million. Turning to the retail commercial truck dealership businesses. Our Premier Truck Group represented 11% of our total revenue in the third quarter. Retail revenue increased approximately 26%, including a 6% on a same-store basis. On a same-store basis, retail gross profit increased 40%, including a 10% increase in service and parts. Earnings before taxes increased 106% to $48 million and the return on sales was 6.7%. The Class 8 commercial truck market remains very strong. And during the third quarter, North American Class 8 net orders increased 28%, and the backlog increased 179% to 279,000 units, representing a 13-month supply. Based on the current industry forecast, retail sales are expected to increase over the next 2 years and provide tailwinds to our commercial truck and truck leasing businesses. Turning to Penske Transportation Solutions, which we own 28.9% of PTS, which provides us with equity income, cash distribution and cash tax savings. PTS currently operates a fleet of over 350,000 vehicles. For the 9 months ended September 30, PTS generated $8.2 billion in revenue and $949 million in income or a 12% return on sales. In Q3, PTS generated $2.9 billion in revenue and income of $409 million or a 14% return on sales. As a result, our equity earnings in Q3 increased 83% to $118 million, while full-service leasing and contract sales were up 8%, our commercial rental revenue was up 51%, and our utilization hit 88%, with an additional 14,000 units on rent. Our consumer rental was up 27%, and our logistics revenue increased 27%. Our gain on sale of used trucks is up 143% as the strong freight environment and a supply shortage of new trucks is certainly driving a demand for used vehicles. I now would like to turn the call over to Shelley Hulgrave, our Chief Financial Officer. Shelley?
Shelley Hulgrave: Thank you, Roger. Good afternoon, everyone. Looking at the PAG balance sheet and cash flow, the balance sheet remains in great shape. At September 30, we have $119 million in cash, and we ended the third quarter with over $1.2 billion in liquidity. When looking at our capital allocation, we maintained a disciplined approach that focuses on opportunistic investments across both our retail automotive and commercial truck businesses, Capital expenditures to support growth, including our CarShop growth strategy, delivering a strong dividend to our shareholders, reducing debt whenever possible and share repurchases. In fact, year-to-date, we have repurchased 2.5 million shares, representing approximately 3% of the total shares outstanding. Year-to-date, we generated $1.3 billion in cash flow from operations. We invested $157 million in capital expenditures, including $18 million to acquire land for future CarShop expansion. Net CapEx was $84 million. At the end of September, our long-term debt was $1.4 billion. We have repaid $922 million of long-term debt since the end of 2019. In addition, we have either repaid or refinanced our senior subordinated debt to lower rates while lengthening the terms to take advantage of current market conditions, which have contributed to a $34 million reduction in interest expense so far this year. These initiatives have lowered our debt to total capitalization to 27% compared to 33.7% at December 31 and 45.6% at the end of 2019. Our leverage ratio sits at 0.9x, an improvement from 2.9x at the end of 2019. At the end of September, our total inventory was $2.6 billion. Retail automotive inventory is $2 billion, which is down $937 million from December last year. We have a 19-day supply of new vehicles. Our days supply of premium is 22 and volume foreign is 9. We expect the current supply challenges, coupled with strong demand to keep our new vehicle supply at low but manageable levels. Used vehicle inventory is in good shape with a 40-day supply. At this time, I will turn the call back over to Roger.
Roger Penske: Thank you, Shelley. Moving on to our digital initiatives. We continue to grow, expand and enhance our digital footprint, including the introduction of new tools and technologies to offer our customers a hybrid customer-driven shopping model. Depending on their preferences, customers can purchase either fully online, in-store, or any combination of the 2, we will also deliver vehicles directly to a location desired by our customers. As part of our omnichannel customer experience, we strive to be a leader in online reputation, including online customer reviews and star ratings on Google. Looking at our other digital tools, we retailed 2,550 vehicles or 4.3% of our U.S. unit sales and 14% of our customers use preferred purchase in their buying journey. Using the Sytner buy-on tool in the U.K., a customer reserve a car for GBP 99, apply for financing, receive instant credit approval, obtain a guaranteed price and pay online. During the quarter, we sold 3,700 units using this platform. When you combine all of our digital tools, including new technology available at CarShop, a customer may perform any part of the transaction online or may use these tools to shorten our visit to the dealership. Looking at corporate development, in addition to the $220 million of year-to-date share repurchases, we completed acquisitions totaling $600 million in annualized revenue through September 30. In October, we acquired the remaining 51% of our Japanese space joint venture of premium luxury automotive brands, which will add $250 million in consolidated annual revenue. We have another $300 million in annualized revenue of deals in our pipeline that we expect to close either in the fourth quarter or early in 2022. We also opened up a new portion dealership in Washington, D.C. earlier this year, and we have 3 other open points under construction. We increased our CarShop locations by 5 and expect to open 1 additional location by the end of the year, bringing our total to 23 locations. We remain on track with CarShop to recall -- to retail $150,000 in unit sales and generate $2.5 billion to $3 billion in total revenue and earn $100 million of EBT by the end of 2023. As we look across our diverse portfolio of businesses, we continue to target organic and acquisition growth as well as further operating efficiencies to continue to grow and expand our businesses. Before I close, I'd like to congratulate the 35 U.S. dealerships that were named by Automotive News to the 100 best dealerships that work for listing. We had more dealerships on the list than any other automotive retailer, including 6 of the top 10, 12 of the top 25 in the 2021 ranking. Our Audi of Turnersville stores ranked number one in the country. Additionally, 7 PAG dealerships rank in the top 10 nationally, including the top 3 places for their efforts to promote diversity, equity and inclusion. We're honored by these accomplishments and are extremely proud of our team for their commitment to drive the passion and the efforts in working together to be one of the very best. I'm also pleased to announce that Penske Automotive Group was ranked first on the listing of U.S. Public Dealerships Teams in the 2021 Automotive Reputation Report published by reputation.com. In closing, our business remains strong, and our record performance demonstrates the benefit of our diversification. I'd like to thank our team for the outstanding results and producing all-time record here for Penske Automotive Group. Thank you again for joining us on the call today for your continued confidence in PAG. At this time, I'll turn it back over to the operator.
Operator: Your first question comes from Rick Nelson with Stephens Inc. Your line is open.
Rick Nelson: I guess, to start, PAG has been less -- we've seen some major deals across the landscape announced recently. PAG has been less active, have been strengthening the balance sheet quite a bit. I'm curious your view of the M&A environment and the multiples and the pipeline for PAG.
Roger Penske: Well, I think it's been an active marketplace, Rick, certainly, with some large deals taking place across the automotive retail space is we know there's 18,000 dealerships and 32,000 franchises. So it's a big sandbox obviously. I think fragmentation provides opportunity for consolidation. With the investment required today, I think there's a number of smaller dealerships that will become available. I think the deals that we see, the bigger deals are expensive. And many of them require CapEx and also then would provide some input from the standpoint of framework agreements with the manufacturers. And basically, over the last 12 to 18 months, I think we've looked at our balance sheet. We've looked opportunistically at things that we could buy and invest in. And I think you've seen that with the roughly $850 million of revenue that we've completed as of today with another 300 under contract. We're growing CarShop organically. We will have added 6 locations. We have, as I mentioned earlier in my remarks, 3 dealerships under construction are new points. And I think what we'll do over the next 12 to 18 months is look at growing probably at about 10%. That's $2 billion a year and that would be divided, not only on a same-store basis, but also in acquisition. And at the moment, we see the opportunity from the commercial truck standpoint that these multiples are quite a bit less in the retail auto, and with Freightliner who's our lead OEM, looking at consolidation, we're taking advantage of that as we go forward when you're looking at businesses that are returning over 6% on sales. So I think that -- at the end of the day, we'll continue our CapEx from a capital allocation, I think Shelly mentioned dividends and share repurchases. But we're going to be opportunistic. We certainly are not getting out of the retail auto business, for sure. And our commitment to CarShop to grow that, I think, is key with our mission that we have to reach 150,000 units by the end of 2023. So I think the deals are done are great for our peers. And to me, it just shows you the opportunity and the profitability in this business.
Rick Nelson: Also, I'd like to ask kind of inventory supply, new, 19 days, any visibility at all into future flows. Do you think we're at a low watermark here with inventory or start to decline?
Roger Penske: Well, we were 12 days here in the U.S. And as you look at the international, add it all together to get to our total number. I've had conversations as late as yesterday talking about inventory going out. I think we'll see in the premium luxury side, we'll see some opportunity for more vehicles coming in November, December. But it's a smaller amount. And quite honestly, everything that comes off the truck is sold or selling into the pipeline. And I think we're going to see that for the next 12 months. I don't think the supply chain is going to get fixed. And the OEMs are prioritizing the models, which is where they make the most money. We see that in the U.K., market was down 33% there lately. And when you look at that, it's not because there's not demand. They're just not building the small people cars because they don't get the margin on those. So I think there's different levers that the OEMs are pulling at this point. But I think it's going to be business as usual here. Tight inventory. All the dealer groups are all looking at ways we can sustain our customers. We're looking to the finance companies and leasing companies to extend leases so we can keep our customers stickier with us as we go forward and being able to order cars for them when they're available. So at the moment, I think the premium luxury people and everyone else are focused on supply chain and they're building cars that don't have some of the -- maybe the additions and accessories that we normally would have. But overall, we outperformed the market here, really looking at -- the market was down 13%, and we were only down 3%. So we feel good where we are, and I think that the market will certainly be a little choppy here for a while.
Operator: And your next question comes from John Murphy with Bank of America Merrill Lynch. Your line is open.
John Murphy: Roger, Tony and Shelley, thank you for the comments here. Just a first question and following up on Rick's first question on cap allocation. I mean, some of the other dealer groups are being much more aggressive and actually taking on leverage. And right now, you're taking down leverage by repaying debt, but you're allocating capital towards growth. So I'm just curious, wanting if you can maybe just give us a quick summation, I mean that 12- to 18-month goal of 10% revenue growth, how much of that is same-store and how much of that is acquisition? And two, if you decided to get more aggressive with the balance sheet, curious if you consider doing that, where you think the capital would be allocated? And are you kind of loading up here for something bigger or a better opportunity? I mean, what's the thought process versus other dealers that we cover that are kind of laying it out on the balance sheet to put it lightly.
Roger Penske: Well, let me say this. We're diversified. So we've got a number of areas that we can actually apply our capital. And I think from a capital allocation perspective, right now, we're looking at the cost of acquisitions. There's no question on the commercial side, truck side, we see that as certainly an opportunity for us. I mentioned it earlier that the Freightliner is positive about us growing. I think from a growth standpoint in the 10% I talked about, I think you look at 50-50, just to keep it simple. And there's no question that when you look at our liquidity, we're at about $1.2 billion plus we've got $100 million in cash. So we're in a great position. Nothing out on our credit lines at the end of the quarter. We have our 2 bonds, which is roughly $1.2 billion. Those are 6 years. I think before they're paid off and 3.75 the rates are good. And we have some mortgages of a couple of hundred. So at the end of the day, I think we're in great shape. But from a standpoint, I'm looking at the market right now with supply chain interruptions not knowing where these multiples are going to go because I don't think when you're looking at pricing some of these deals and looking at a trailing 12, you're looking at probably the biggest market and most profitable market we've had in many years. So I think I want to stay -- keep my leverage down and my opportunities in front of us, we can move right away. And we could lever up to 2.5 to 3 if we wanted to for a big deal. But I have nothing right now that would say that we're in that mode. But we get a chance to look at these. In the past, we've passed, and I think we'll be very selective. And if we have areas where we can add on, where we have scale and consolidate, we'll be in there with a big number. But at the moment, I think we're going to take a patient look and try to understand what this market is going to bring us over the next 12 months.
John Murphy: And just a follow-up to that. I mean if we think about growth via acquisitions over the next 12 months or so. I mean is that the kind of redeployment you think would be something we should think about going forward beyond that? Or because you're taking leverage down, that might be somewhat conservative in that over time as opportunities avail themselves, and you've got the balance sheet firepower to go after them, that may end up proving being a somewhat conservative way to think about acquired revenue growth going forward?
Roger Penske: Yes, I would say it's conservative. And I think if -- look, we have to put a number down and work towards a number. And I think that's realistic when you're looking what our same store revenue is from year-to-date and looking into 2022 and then looking at what we have potentially from an acquisition standpoint. I think that's realistic. We got these new points opening. We've got the opportunity from CarShop perspective to grow same-store. And on the other hand, if there's a big deal out there, that's how we built the company. Remember, we were in a pretty much of a buying mode early on. And I think that what we'll do is see just exactly what's available to us. I think the -- right now, when you look at CarShop, we have the ability to grow that many times over with capital, and it's a lot less. We don't have the structure in front of us framework and some of the areas that we have to deal with the OEMs, with CarShop. I think the brand has really taken off both here domestically and internationally. So that's certainly going to be a focus.
John Murphy: And then just a second question on SG&A. You've taken a lot of heads out. I'm just curious where you think the SG&A costs will go. I mean, I don't know if you can talk about in absolute terms or a percent of gross. I know that's kind of hard because there's a lot of moving pieces. But I mean, how do you think you should think about SG&A to gross or SG&A costs in total going forward?
Roger Penske: Well, I think I looked at SG&A, where was our -- during the quarter, and it's interesting that overall, we've taken about 8% of our people out since pre-COVID just from an overall standpoint and almost, almost 2,000 people. When you look at SG&A, and our comp was up about $100 million during the quarter. That basically was based on variable comp and the margins that we have. But we look at SG&A, we'll probably be in the low 70s. We're better than that today. We've come down from 77. But I don't want to mislead anybody. I think the gross is driving a much better looking number than it might be on a going-forward basis. But I would say low 70s.
John Murphy: That's helpful. And then just lastly, I mean, I appreciate the details on digital initiatives. And just curious if you could talk about a little bit what you're doing with Cox now because it's a newer -- a much newer initiative. But also as you think about that and your other efforts and how they ultimately will dovetail with some of the efforts of the automakers that are kind of trying to create a digital overlay in interaction with the consumer, which is almost analogous or similar to what a lot of dealers are investing in. Just curious how you think one way you're doing near term with Cox; and 2, longer term, how do these systems ultimately interface, interact or maybe compete with what the automakers are doing to some extent because they're getting pretty heavily invested as well in their digital efforts.
Roger Penske: Well, I think that we kind of have a hybrid approach really when you look at it. We've got third-party sites. We've got the OEM digital sites and then are also using social media. . But at the end of the day and you look at the Cox piece, we spent about a year or so with Cox. And I think if you -- anybody use the product at all at this point, it's excellent. We only have 2,000 units on the platform right now because it's in the early stages, and we've done about 300 units of sales. That's both either people getting off the site and moving into the dealership or directly all away from end to end, which we think is a good start with very little issue. From a CSI perspective, we've gotten lots of complements on that platform. And I know Cox has got -- they're looking at it. They're watching it. It's very important to them that it's successful. But on the other hand, one of the things that I've cautioned our people, we see all these opportunities. But probably the thing that I want to do most is partner with the OEMs because they're all rolling out an e-commerce platform. So it's going to be part of your relationship is like your floor plan, it's like some of your financing. I think you don't want to use their platform. And today, Toyota has a smart path and Lexus has monogram and many has anywhere. So these are all in a position today that I think we got to take a good look at. And we're in the process of signing up for those as we go forward. So to me, I think that's going to be key. And I think the Internet sales are going to be key, but we're still going to have people because of the premium luxury brands that we have are going to come in and kick the tires for sure. But I think the omni-channel certainly is just not selling vehicles. You think about service appointments, online payments, this is key. We had today, between our BDCs and our online service appointments over $500,000 when you look at that in the quarter. And the online payments continue to grow. I think we collected almost $50 million during the quarter on online payments. So to me, this is key because the average payment is almost $1,000. So we're using this online channel, obviously, for more than just selling new and used vehicles.
Operator: Your next question comes from Stephanie Moore with Truist.
Stephanie Moore: I wanted to talk a little bit. You did speak on just what we're seeing from these underlying trends on the auto retail side, there's supply chain disruption. But maybe you could touch a little bit on what we're seeing on the commercial truck side and the freight environment, obviously, having a nice benefit to both your JV as well as the commercial shop retail business right now. But maybe you talk about the longevity you expect some of these trends as well as maybe some of the positive attributes that might come out as a result of environment, whether it's on pricing or the used truck market or anything like that?
Roger Penske: Well, I think we've got to go back a little bit. As you know, we have electronic logs now for drivers, and that was instituted here several months ago. And what happens where people are running 2 log books and being able to run maybe 12 to 18 hours a day, they're not able to do that now without breaks and what that's done. That's certainly in a position that has created more driver requirements, and yet we can't get drivers right now. And with that, there's a shortage to move goods. And 85% of the goods are moved by truck here in the U.S. And from my perspective, we see the truck business is core. When you look at the demand with the OEMs, almost a 13-month backlog, that's for heavy duty from the standpoint of 279,000 units at this point. And that's going to drive this business for the next 12, maybe even 24 months. And that's what's driving the used truck prices up because today, most of the fleets can't get their new trucks right now. So they're running their old trucks, maybe another 5 to 6 months. And that's also helping drive this used truck value, but I don't see it slowing down. And to me, right now, the biggest issue is the number of trucks that are sitting at these OEMs without parts. And I know Freightliner right now is making -- having a big focus on completing the trucks that are on the ground, which will help us. And I think that's going to take some of this backlog down. But based on what we're hearing, the first quarter, we're probably going to end up be delivering trucks that should have been delivered in the fourth quarter. So that's going to push this whole supply chain out, at least 90 to 120 days late from where it should have been. So I see it obviously being a positive for us from the standpoint of our rental business on the truck leasing side because people need extra equipment, and that's the business we're in, it's commercial rental.
Stephanie Moore: Absolutely. That's really helpful. And then I think over the last year, really have seen the strength, whether -- in the capital allocation, whether it's through purchasing shares, obviously, raising the dividend, debt pay down. As you look forward, I think opportunistic M&A has already come up on this call, but where do you stand in terms of continued debt paydown, share repurchases as we look out for the next 12 months?
Roger Penske: Well, from a debt paydown perspective, we really have mortgage debt that we have that's variable that we can pay some of that downward which we would. And I think we've got dividends, which we continue to grow the dividend base. And from a share repurchase perspective, that's going to be something that will -- we have a $70 million right now of authorization from the Board, and we just really moved that to 250 back in July. So we'll sit with our Board in December, and we'll look at that allocation going forward. So we've got share buyback. We certainly got M&A, which we've talked about strategically, maybe from a commercial truck perspective, opportunistically, when we look at the retail automotive side, and then we're going to absolutely develop and invest in the CarShop part of our business. So I think there's plenty of areas to use our capital. But again, we're going to keep our leverage where it is. And then if there's a big deal, we can step up, we don't need to go to the market for extra capital. We have $1.2 billion to $1.3 billion right now available from the standpoint in our credit lines, and that's without any other -- leverage of any other assets. We only got about 24% of the book value of our real estate being merged at the moment.
Operator: Your next question comes from Mike Ward with Benchmark Company.
Mike Ward: Is there a way to rank the capital requirements when you look at these growth investments, whether they're open points, truck distribution, CarShop, M&A, is there a way to rank which ones are from either high to low or low to high as far as capital requirements when you do those?
Roger Penske: Well, from a CarShop perspective, I'm going to just take it as it come to mind. We have significantly less investment in a CarShop location. We're just opening one in Phoenix, just opened one this week, which probably the investment is about $12 million total. And the one over in New Brunswick was about the same. And I think when you look at those locations and the returns, they're much greater than they would be if we had to build a premium luxury store in the same place. But I think it's lower investment. When you look at return on sales, we're in the, say, 2%, 3%, 4% on the retail side, I think from a truck perspective, commercial truck is looking at somewhere between 5% and 7% return on sales. So that certainly would become also a priority for us. So the opportunity also, which we haven't talked much about is in Australia, as we start to grow that -- continue to grow that business as we have defense, we have big power gen capabilities there. We have -- certainly have our on-highway and our mining business is there. And we continue to invest in equipment and facilities out there. And today, we have some single source contract with the government on defense going forward. So our capability there to get more vertical with the government will be certainly an area we would spend some money on in order to have those long-term 5- and 10-year contracts, and those are quite profitable also.
Mike Ward: So -- and with your joint ventures, bringing them in from Japan, does that open up additional opportunities in Japan with your partners?
Roger Penske: There's no question. We really wanted to -- now Mitsui is a partner of ours. We're a big player with Toyota and Honda. So we wanted to be in that market. We did a joint venture there a number of years ago. And what we wanted to do was get our feet wet there and understand what was the requirements from accounting perspective, from a controls and risk. We've operated in that business now for probably about 5 or 6 years. We're the Alpina distributor for all of Japan. We're a big BMW dealer there. We have Rolls-Royce and Ferrari, and along with many. And I think when you look at it, the OEMs have come to us a number of times wanting to us add to our platform, and we would expect to do that with the management team we have in place. Our former partner has moved to nonexecutive Chairman. So we still have some oversight with him. But we have a gentleman that's been there now for 4 years, really learning the business, came from the OEM side, an American who's learned Japanese, has a Japanese wife and he's really done a great job. So we think we're in a position with the controls in place now and we'll go forward and that will be a growth area for us.
Mike Ward: A couple of questions for Shelley. Shelley, maybe starting off first. When you look at your debt ratings and your right on the cusp of investment grade. Is there any plan? Or does it benefit you to get moved up to investment grade? Or is that just irrelevant?
Shelley Hulgrave: No. Given the strength of our balance sheet, we can certainly have those discussions with the rating agencies. Like you said, S&P upgraded us to BB+ in May, and we're BA1 with Moody's, so just below investment grade right now. It's not a priority for us, but it never hurts for us to have those discussions. Yes. Our lease adjusted leverage ratio is now at 2x when the requirement is 3. So we do have some cushion, as Roger had mentioned earlier. Clearly, there's upside from an interest rate perspective, probably about 100 basis points on future bond offerings. We're just evaluating the potential policy restrictions. So as we look at our capital allocation strategy, we wouldn't want to risk a potential downgrade, but we wouldn't want to pass up a significant opportunity either.
Mike Ward: What is the impact on cash flow as inventories replenished over the next year or 2?
Shelley Hulgrave: Well, we floor the majority of our inventory purchases like. So the impact is really eliminated and we're not expecting, as Roger mentioned, a quick return to inventory if at all, to prior levels. So we continue to see a buildup of pent-up demand, particularly with the lease returns starting to come off those stronger tariff years. And as we've seen the production returns will be gradual. So very minimal impact.
Mike Ward: And just one last one. Some of your peers are starting to get into the finance business. Given you're generating so much cash, and it looks like it's going be at similar levels, at least through the end of '22, are you considering that at all? Or have you looked into it the plus and minuses of starting a finance arm?
Shelley Hulgrave: We have, from time to time, evaluated those pros and cons, Mike. The decision typically comes down to the return of capital. And as we've talked about, we're experiencing some pretty great returns on PTL or PTG acquisitions. And even our recent Mercedes store that we acquired here in April. So plus the majority of our transactions on the premium luxury side are on the leasing side, and we have an 80% penetration rate with our new vehicle sales. So when you look at that and our small subprime business, I'm not sure starting a finance company really makes a lot of sense right now.
Roger Penske: Yes, Mike, we've looked at it. In fact, it was a discussion item at our latest strategy meeting. We can't borrow money like the banks can. So in order for us to get the kind of return we want, we're going to have to go down in credit rating in order to be able to attract the kind of returns we want. And it starts to burden your balance sheet, certainly, we can securitize over time. And then the lease account or the accounting requirements there that we have to take in the income over 30 months, 40 months or 60 months depending on the term of the contract. So I would say, right now, when you look at our subprime business, only 6%. So I think we're in a good position. It's something we continue to look at. We've seen other people take that on. And look, we're different, and I think that we'll probably not be getting into that business at this particular time.
Mike Ward: Just a follow-up earlier. When you talk about these open points, and I think you have 3 open points. Is that something we can expect to see more of? And that's not just U.S., right, it's Europe as well?
Roger Penske: Right. Well, obviously, we got open points in CarShop, which we can designate those to ourself. Now we've been the OEMs to get some -- we've got 2 open points in Austin. We, of course, had the open points in Porsche. We got open points in the U.K. So I wouldn't say you're going to get 3 or 4 every year. But where we have scale and where we've proven to be a good operator, we've had this opportunity, we apply for those, and we've been successful. So we see those as a good way to grow. We're growing the way we want. We're able to build purpose-built facilities that meet the CI and not have to jump into much a corporate identity when you're buying a bunch of stores that are not brand new. So we see that obviously as a positive.
Operator: Your next question comes from Rajat Gupta with JPMorgan.
Rajat Gupta: Sorry to ask you once again on capital allocation, just balance sheet leverage. I mean, you're going to be generating a significant amount of free cash flow here over the next year or so given this elevated margin profile. It doesn't look like the M&A multiples on the automotive retail side seem attractive. You already have some capital committed for CarShop, which is kind of well understood. Given like we are in this like longer, would you consider like a big buyback, you don't even have to add like a ton of leverage to do like maybe even close to $1 billion, given you're generating more than like $800 million or so of free cash flow. Just curious what's your take on that? And would you consider doing it a big buyback in the interim, given this excess level of free cash flow? And then I have a couple of follow-ups.
Roger Penske: Well, I think share buyback is something that we discussed with the Board. And as I said earlier, that we'll have that discussion in our December meeting. And that's always an option for us on a going-forward basis. We've been pretty much consistent, increasing our dividend $0.01 of shares we've gone forward over many quarters. And we had $250 million of buyback authority. We thought that when you start looking at options for our capital that share buyback was certainly prudent during the last quarter. Now those same conditions could take place in the future, and that would be reviewed by the Board, and we'd make those decisions at that time.
Rajat Gupta: Got it. And just shifting gears to GPUs. On the new vehicle side, I'm assuming that the absolute GPU continue to get better through the course of the quarter, you're likely exiting the third quarter a higher run rate than your average. Just based on what you're learning from OEMs, the supply, can we sustain this kind of high 5,000 number for a few more quarters? Or do you see this coming back to more normal -- not normal, but like do you think the third quarter is the peak year for you?
Roger Penske: Well, I think I've had that question before. And when I look at entering the quarter and then exiting the quarter, there was no question that grosses -- new vehicle grosses went up month-to-month. July, August and September, also our use went up. I think at the end of the day, when you look at MSRP, that's the manufacturer sales price, suggested sales price, where some people who are selling above that. I think that that's a very dangerous territory right now because what it does to your customer over a long period of time, you really don't know. So I think that on the used car side, we're probably close to the top. And because we have nothing on the ground and you're selling into the pipeline, you're going to continue to hold good margins. Now whether it's within $100 what we have today, I think that the sustainability of the grosses right now will be dependent on supply.
Operator: Your next question comes from David Whiston with Morningstar.
David Whiston : First, on the truck space. Roger, you talked earlier about there's just -- it's just taking too long for new trucks orders . So is that purely the chip shortage? Or is there -- are there some supply chain issues on top of that, that are more of a problem?
Roger Penske: Yes. Listen, people don't realize they're air freighting tires now, lots of things other than just chips on the heavy-duty truck side. So I think the key thing here is we look at it. When you look at the manufacturing businesses -- and plants are losing their people. They've lost people and trying to crank back up again. There's some human capital requirements that they're meeting. And again, they have to be trained. I talked to 1 OEM the other day, and they said, any one day, they could be down 25% of their workforce. So how do you run your plant on a quarter your people don't show up on Monday morning. So I'm not saying this is any particular truck OEM, but this is pretty much what you'd see in the marketplace. But right now, there's a big demand for heavy and medium-duty trucks. And the supply isn't there. And quite honestly, we've seen the impact of that on our Penske Transportation Solutions business because with our 88% utilization rate on our tractor base, which is up 14,000 when you look at total units, it's amazing. And we don't see that slowing down really. Some of the consumer rental, which is the one way, that will come back probably 15% to 20% in Q4. But overall, I think you're starting to see the deliveries of the heavies are going to be pushed out into Q1 and Q2. And that's just strictly availability of all components. And when you have tens of thousands of units sitting on the lots of the OEMs aren't finished, they've got to focus on those before they build more new trucks. They just don't have the space.
David Whiston : That's helpful. And then in the U.K., consumers are dealing with a lot of shortages, particularly even fuel. Is that causing a lot of havoc at your stores in terms of people not wanting to buy a vehicle?
Roger Penske: We don't -- I don't see that. I think electrified vehicles have gone up. If you look -- I don't have the number right here in front of me, but there's no question that demand is still strong, and there's been a movement -- a bigger movement to electrification. Maybe some of that has to do with the shortage of fuel. But the big issue there is drivers to drive some of these big rigs because a lot of them went back to Western, Eastern Europe when COVID hit and haven't come back. In fact, I think Johnson was giving some permits for 5,000 people to come in as drivers in order to drive some of this equipment, which certainly has had an issue. Hybrids seem to be what's the hottest sector in the U.K. right now because that gives you the opportunity to go into cities like Los Angeles and Birmingham and places like -- into London in Birmingham with a hybrid vehicle. And most people have to pay a tax when they buy an ICE engine. And if you have an electric vehicle, you pay no taxes. And that's -- in the company cars, that's a big factor from the standpoint of what they pick. So that's also driving electrification.
David Whiston : Okay. And PTS, the press release cited operating expense reductions, where are those primarily coming from?
Roger Penske: Say that again, PTS?
David Whiston : Yes. There's operating expense reduction side in the press release. I was just curious if that was coming from operational moves or headcount reduction.
Anthony Pordon : Headcount. It's efficiency and headcount across our business. We've got -- Roger mentioned, we're down about 2,000 people or 8%, 9%, David, across our business. It's not just -- it wasn't specific to PTS. It was specific to our overall business.
David Whiston : Okay. And last question, I'm asking everybody this. Are you seeing any change compared to a few months ago, whether it's a CarShop or on the traditional side, are consumers just getting fed up with the shortages and just saying, I'm not going to get a use, I'm going to wait until you have more new inventory, or conversely, are people more desperate?
Roger Penske: I think one of the things on the use side is the prices are getting so high. It's almost like sticker shock that can almost buy a new car, but of course, they're not available. So some people might be sitting on the side in order to get pricing right and then availability of new vehicles, too, they have another option. That's what I see right now.
Operator: There are no further questions at this time. I'll hand the call back to Roger Penske.
Roger Penske: Thank you, Jerome, and thanks, everyone, for joining us today. We'll see you next quarter.
Operator: Thank you. And that concludes today's conference. Thank you all for joining. You may now disconnect.
