Downgrading Penske to a Hold

Penske Automotive Group, Inc. (PAG - Analyst Report) has a unique business model, a strong luxury automotive market, and a high growth rate. However, rising interest rates, challenging industry conditions and a leveraged balance sheet dampen our outlook on the stock. Thus, we lower our rating to a Hold.

The used-vehicle market in the U.S. is challenging owing to the relative affordability of new vehicles, spurred by attractive pricing and cash-back offers. The company’s gross margins are below average due to a lower finance and insurance contribution. Since Penske Automotive’s customers tend to belong to a higher income group, they rely less on car financing.

The company also has a huge amount of debt on the balance sheet and most of it is variable-rate based, whose cost increases with higher interest rates. Further, higher interest rates will make the financing of acquisitions more expensive.

Currently, shares of Penske Automotive Group are trading at 10.0x our 2008 EPS estimate of $1.66. We set a six-month target price of $18.50, which is 11.1x our 2008 EPS estimate.

Read the full analyst report on PAG