Penske Automotive Group Inc. (PAG)
Owner-Operator: Roger Penske
Penske is the second largest auto retailer in the U.S. (after AutoNation Inc., also a Fund holding), with a significant international presence in the U.K. and Western Europe. Chairman and CEO Roger Penske owns nearly 38% of the company’s shares. Penske is active in new and used car sales, focusing on the luxury market, service and parts, and financing. Of these, service and parts is the highest margin segment and the largest driver of profitability. In the second quarter of 2016, service and parts contributed 10% of retail automotive dealership revenues and 41% of gross profit. Furthermore, service and parts typically lags new vehicle sales (customers bring their cars to the dealership for service for several years following purchase). While same-store vehicle sales were relatively flat from Q2 2015 to Q2 2016, service and parts sales rose over 3%.
In addition, the company has an ownership interest in Penske Truck Leasing, and over the past year-and-a-half increased its footprint in the commercial truck dealership market through acquisitions. Sales of heavy-duty trucks carry higher margins than premium cars, and the associated service and parts margins are extremely high. The shift in revenue mix toward higher margin vehicle sales and service and parts bodes well for margin expansion and earnings growth.
In spite of substantial stock price appreciation over the past few years, it still appears that Penske’s stock is trading at a low price-to-earnings (“P/E”) multiple. If, in a year’s time, Penske were able to reach a valuation merely in line with its peer average, that would result in a return of almost 15% (including dividends). Should its valuation multiple expand to its long-run average of about 14.5x earnings, we believe the return could exceed 30%.
Loews Corporation (L)
Owner-Operator: Andrew Tisch
Loews is a holding company operated by the current generation of the Tisch family. The company’s primary operating assets are a 90% stake in CNA Financial, 53% ownership of Diamond Offshore, 51% of Boardwalk Partners LP, and full ownership of the Loews hotel franchise. Most of these investments were orchestrated decades ago by the original founders, Laurence and Robert Tisch. Apart from CNA Financial, which is a property and casualty insurer, Loews has considerable exposure to the oil and natural gas industries through Boardwalk Partners LP and Diamond Offshore. Given the depressed price of oil, these businesses have been under pressure and are trading at low valuations accordingly.
The Tisch family collectively owns approximately 23% of Loews’ shares and has been repurchasing them aggressively over the past several years —unsurprising given that the holding company trades at both a discount to book value and a discount to the aggregate public market value of its various subsidiaries, which themselves trade at discounts to book value and at even greater discounts to valuations based on normalized figures. On the basis of such valuations and the various dimensions of undervaluation available through the holding company structure, it could be argued that the company’s shares trade at a discount to fair value of roughly 50%.