Analyzing Penske Automotive Group’s Dividend Growth Potential

Recap from December’s Picks

On a price return basis, the Dividend Growth Stocks Model Portfolio (5.3%) outperformed the S&P 500 (+4.4%) by 0.9% from December 29, 2022 through January 25, 2023. On a total return basis, the Model Portfolio (+5.4%) outperformed the S&P 500 (+4.4%) by 1.0% over the same time. The best performing stock was up 12%. Overall, 21 out of the 30 Dividend Growth Stocks outperformed the S&P 500 from December 29, 2022 through January 25, 2023.

The methodology for this model portfolio mimics an “All Cap Blend” style with a focus on dividend growth. Selected stocks earn an attractive or very attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield >1%, and have a 5+ year track record of consecutive dividend growth. This model portfolio is designed for investors who are more focused on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.

January’s Featured Stock: Penske Automotive Group

Penske Automotive Group (PAG) is the featured stock from January’s Dividend Growth Stocks Model Portfolio.

Penske Automotive has grown revenue by 8% compounded annually and net operating profit after tax (NOPAT) by 17% compounded annually since 2012. The company’s NOPAT margin rose from 3% in 2012 to 6% over the trailing-twelve-months (TTM), while return on invested capital (ROIC) rose from 5% to 12% over the same time.

Figure 1: Penske Automotive’s Revenue and NOPAT Since 2012

Steady Dividend Growth Supported by FCF

Penske Automotive has increased its dividend from $1.26/share in 2017 to $2.12/share over the TTM, or 12% compounded annually. The current quarterly dividend of $0.53/share, when annualized, equals $2.12/share and provides a 1.8% dividend yield.

More importantly, Penske Automotive’s free cash flow (FCF) easily exceeds the company’s growing dividend payments. From 2018-2021, Penske’s cumulative $3.3 billion (19% of enterprise value) in FCF is 7x the $463 million paid out in dividends, per Figure 2. Over the TTM, Penske has generated $465 million in FCF and paid out $150 million in dividends.

Figure 2: Free Cash Flow Vs. Dividend Payments

Companies with FCF well above dividend payments provide higher-quality dividend growth opportunities. On the other hand, dividends that exceed FCF cannot be trusted to grow or even be maintained.

Penske Has Upside Potential

Despite Penske’s profits being very strong recently, its current stock price implies a significant decline in profits. At its current price of $128/share, PAG has a price-to-economic book value (PEBV) ratio of 0.6. This means the market expects Penske Automotive’s NOPAT to permanently decline by 40%. This expectation seems overly pessimistic for a company that has grown NOPAT by 17% compounded annually since 2012.

Even if Penske’s NOPAT margin falls to 4% (equal to five-year average vs. 6% over the TTM) and the company grows revenue by just 4% compounded annually for the next 10 years, the stock would be worth $162/share today – a 27% upside. In this scenario, Penske’s NOPAT would grow less than 1% compounded annually over the next decade. See the math behind the reverse DCF scenario.

Should the company grow NOPAT more in line with historical growth rates, the stock has even more upside. Add in Penske’s 1.8% dividend yield and a history of dividend growth, and it’s clear why this stock is in January’s Dividend Growth Stocks Model Portfolio.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specific adjustments I made based on Robo-Analyst findings in Penske Automotive’s 10-Ks and 10-Qs:

Income Statement: I made $332 million in adjustments with a net effect of removing $221 million in non-operating expenses (1% of revenue).

Balance Sheet: I made $4.7 billion in adjustments to calculate invested capital with a net increase of $4.7 billion. The most notable adjustment was $863 million (9% of reported net assets) in operating leases.

Valuation: I made $8.4 billion in adjustments, all of which decrease shareholder value. Apart from total debt, the most notable adjustment to shareholder value was $1.1 billion in deferred tax liabilities. This adjustment represents 12% of Penske Automotive’s market value.

Disclosure: David Trainer, Kyle Guske II, and Italo Mendonça receive no compensation to write about any specific stock, style, or theme.