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On Jan 29, we downgraded Penske Automotive Group Inc. (PAG - Analyst Report) to Neutral from Outperform. The downward revision was based on increasing competition, high inventory level and negative impact of foreign exchange rates. However, the company is poised to benefit from recent acquisitions, rising sales of new vehicles and a strong financial position.

Why the Downgrade?

On Oct 29, Penske posted a 21.7% increase in adjusted earnings per share to 73 cents in the third quarter of 2013 from 60 cents in the corresponding quarter of 2012. The results also exceeded the Zacks Consensus Estimate by 3 cents.

Revenues improved 14.6% year over year to $3.8 billion, beating the Zacks Consensus Estimate of $3.7 billion. The year-over-year rise in revenues was driven by increase in retail sales.

Following the release of the third-quarter results, the Zacks Consensus Estimate for Penske’s 2013 earnings increased 0.7% to $2.72 per share. The Zacks Consensus Estimate for 2014 rose 1.3% to $3.18 per share. Currently, Penske carries a Zacks Rank #4 (Sell).

Penske Automotive is expected to benefit from the acquisitions of dealerships of Frank Smith Toyota-Scion of Toyota Motor Corporation (TM - Analyst Report) and Hyundai in Pharr, Texas. These dealerships are expected to generate additional revenues of $200 million annually. Penske expects these dealerships to complement the existing dealerships in Austin, Houston, and Round Rock, Texas.

Penske Automotive has been benefiting from increased new vehicle sales over the past few years. The company expects the U.S. and U.K. automotive market to perform well in the future. This will enhance its business opportunities.

Penske Automotive competes with other franchised automotive dealers including AutoNation Inc. (AN - Analyst Report), private market buyers and sellers of used vehicles. Rising competition and increasing price transparency is expected to lead to lower selling prices thereby affecting the profits of the company. We are also concerned about the huge merchandise inventory. As of Sep 30, 2013, the company’s inventory comprised 75.5% of current assets.

Other Stocks to Consider

Lithia Motors Inc. (LAD - Snapshot Report) carrying a Zacks Rank #2 (Buy) is performing well in the auto and truck industry.


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