Penske’s outlook seen as improved by S&P Ratings, debt rating holds steady

Penske Truck Leasing is a private company, which means outsiders don’t get much of a look at its finances.

That changes when a debt rating agency reviews the company, as S&P Global Ratings (NYSE: SPGI) has just done with Penske Truck Leasing. And the outlook is mostly bullish.
S&P Ratings did not raise the company’s debt rating, which stands at BBB, one of the lowest that is still considered investment grade. But the outlook on Penske was raised to “Positive” from “Stable.” A Positive outlook means the rating may be raised by S&P given certain market conditions.

S&P defines a company with a BBB rating as one that “has adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to weaken the obligor’s capacity to meet its financial commitments.” It is two notches above non-investment grade, colloquially known as “junk.”

At BBB, Penske has the same rating as its competitor, Ryder Systems (NYSE: R). A year ago almost to the day, S&P did the same thing with Ryder as it did with Penske last week: It held the rating at BBB and raised the outlook to Positive.

Penske leases and resells Class 8 vehicles, as well as both renting and leasing a wide range of smaller trucks, right down to vans.

Ratings agencies, such as Moody’s and S&P, do not disclose profit/loss information for private companies like Penske. But they will refer to it with vagueness, and the report on Penske serves as an example of that.

Strong truck market conditions at Penske, S&P said, “have contributed to higher revenue and profitability.” In the 12 months ended March 31, 2022, according to S&P, Penske revenues were up about 25% from the corresponding quarter a year ago. Its earnings before interest and taxes–EBIT–ran at a rate of the “mid-teens,” up from about 11% to 12% in the first quarter of 2021. The EBIT ratio is expressed as a percentage of revenue.  Overall, these factors have contributed to higher revenue and profitability. 

S&P said Penske has benefitted from slow deliveries of vehicles, as customers that have ordered new deliveries whose arrivals are delayed by a variety of supply chain problems have needed to rent vehicles while waiting. With expectations that those delays will ease, “we believe higher truck production and lower demand for freight transportation will moderate growth over the next two years,” S&P said. “Improving supply chain conditions should allow truck manufacturers to fill orders more quickly. Meanwhile, slower economic growth and more normalized consumer spending patterns should reduce overall demand for truck transportation, reducing demand for new leases and utilization in Penske’s commercial rental fleet.”

Much like Ryder, Penske’s finances are heavily influenced by the resale prices it receives for used vehicles. Given the S&P expectation that supply chain bottlenecks will ease and new vehicles will come off assembly lines at a more predictable rate, “we expect these factors will reduce used vehicle prices,” S&P said. That will contribute to a moderating revenue growth at Penske this year of 10% to 11%, sliding further to the “mid-single-digit percent area” next year.   

“Although we believe Penske will continue to report gains on vehicle sales due to its consistent depreciation policy, lower used vehicle prices reduce gains,” S&P said. It added that it sees EBIT margins moving back to the 11-12% area next year after its foray into the mid-teens range.

Ratings agencies review companies on their ability to service their debt, not just on a strict profitability basis. The rationale for the company to have its outlook improved is clear in its EBIT coverage of debt obligations, which S&P said improved to 5X debt payments for the first quarter, from 2X a year earlier. The company’s debt to capital ratio dropped to the low 70% range from “about 75%” a year earlier, S&P said.

That coverage will not be maintained, S&P said, primarily because of the expectation of lower used vehicle prices. 

But Penske is more than just used sales vehicles, S&P notes. In its leasing and rental activities, “given the mostly contracted nature of the company’s business, we believe metrics will continue to benefit from recent pricing gains even amid a more moderate operating environment.” 

Most Penske leases are four to seven years, S&P said. That duration “limits the number of contracts coming due for renewal each year and allows the company to lock in favorable pricing for an extended period.”

The report also notes that Penske only buys equipment when it has a lease for those trucks. “This provides visibility into Penske’s capex requirements,” S&P writes. “Should demand decrease further than we forecast, we expect the company would reduce capex and generate positive free operating cash flow.” 

But without providing numbers, S&P said its base case for free operating cash flow at Penske “remains negative over the next two years,” with the expectation Penske will issue additional debt.

A consistent theme through ratings agencies’ actions is the need to generate sufficient free cash flow to cover debt requirements.  

The S&P analysis also revealed that Penske pays a dividend to its owners that is 50% of current year net income. Penske Truck Leasing is a partnership of Penske Corporation, Penske Automotive Group and Mitsui & Co.. It is based in Reading, Pa.

Penske has a Supply Chain Management division and Dedicated Contract Carriage division. S&P spoke positively of the latter group: Penske “will continue to benefit from the long-term shortage of truck drivers. Penske’s national scale and focus on shorter hauls allow it to hire drivers more easily than smaller operators.”

In an indirect reference to Ryder, S&P said Penske has pursued “tuck-in” acquisitions, but hasn’t made acquisitions in contract logistics or e-commerce. 

By contrast, Ryder last year acquired Whiplash, a company in the last mile segments, and warehouse company Midwest Warehouse & Distribution System.  

A spokesman for Penske declined comment on the S&P report.

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