Our equities writer considers the investing merits of a much maligned but increasingly lucrative part of the business world.
With commercial radio plagued by adverts for online used car sales – new entrants such as Cazoo (preparing for a US listing) and Motorway.co.uk – you might assume traditional dealerships are being elbowed out.
Currently, however, there seems space for all because the used car market is going gangbusters; partly because consumers are waiting for prices of electric cars to come down, also battery duration and charging facilities to improve.
Among listed dealerships, it is notable how both £170 million Vertu Motors (LSE:VTU) at 46p and £188 million Marshall Motor Holdings (LSE:MMH) at 242p have enjoyed very strong trading so far this year – with serial upgrades in expectations.
Despite rather tight supply conditions, they have been able to maintain stock/sales at higher levels than anticipated. How durable are such conditions though?
Not exactly the ideal financial mix, investors seek
Dealers’ business models are typically compromised by low operating margins, which mean variable cash flows, meanwhile the tables both for Vertu and Marshall’s show quite material capital expenditure needs.
It is therefore challenging to establish a sound record for dividend growth, arguably the touchstone for investment value.
Variable earnings also mean low price earnings (PE) hence these stocks looking perennially cheap.
Yet such companies fulfil an essential service in vehicle supply, hence if the stock market stubbornly refuses to recognise value there is a fair chance private equity buyers will move in – given interest rates are very low.
Exactly where “fair value” lies is therefore quite mercurial and to an extent depends on your timescale.
First half of 2021 has been a blow-out period
Not only has used vehicle demand been strong, after-sales service revenues/profits also strengthened after last year’s lockdowns impacted annual service and MOT work.
On 29 July and due to “exceptional UK used car market conditions”, Vertu Motors declared a bumper update – both for sales and gross margin retention – such that adjusted pre-tax profit of “no less than £40 million” is expected for its first-half-year to end-August.
The rest of Vertu’s financial year to 28 February 2022 is uncertain though: new vehicle supply is constrained due to microchip shortages, also Covid 19 disruption remains and there is now upward pressure on employment costs plus labour shortages.
Adjusted pre-tax profit for Vertu’s financial year to 28 February 2022 is therefore guided only for £40-45 million – even if up substantially from a previous budget for £28-32 million.
Yet the board remains “very confident in prospects for the group, which is strategically well placed to capitalise on changes and opportunities in the UK motor retail sector.”
It is the kind of carrot, you wonder if will prove a polite excuse should the car market and earnings eventually turn down, or justifiably hints at takeover potential.
Remarkable similarity between Vertu and Marshall’s currently
On 4 August, Marshall’s declared annual profit to 31 December to be “well ahead of the group’s historic record result” likewise “no less than £40 million” albeit with a range of possible outcomes.
Management sounds more positive that Vertu’s on the demand/supply situation for new and used vehicles, and also cites “unprecedented value appreciation” – as positive tailwinds.
After-sales service is actually the most profitable area for Vertu: its end-February 2021 accounts showing 43% of gross profit derived from aftersales (which enjoys a near 50% margin), 31% from used vehicles (9% margin), 18% from new (7% margin) and 8% from fleet and commercial (4% margin).
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Marshalls has likewise been boosted by after-sales representing 46% of gross profit with the remainder split quite equally between new and used cars.
Consensus forecasts for both companies look as if needing substantial upgrades given Vertu is projected to make just £15 million net profit this year and £19 million next; and Marshall’s £26 million easing to £18 million in 2022.
At current share prices of 46p and 242p respectively, even the “old” forecasts implied 12-month forward PE scenarios of just 6x and 9x – as if upgrades should then offer some “margin of safety” even if trading conditions eventually moderate.
Current prices ought to offer value despite a likelihood of earnings moderation.
Modest 3% to 4% yields keep earnings in focus
If dividends were material and dependable enough, then investors might be less fussy over near-term earnings.
Vertu is expected to raise its dividend to around 1.8p a share, for a circa 4% yield, while 7p or so for Marshall’s implies more like 3%.
I doubt either board will re-rate the pay-out more significantly due to the industry’s variability and capex needs. Thus, earnings cover for dividends has tended to be kept around a median 4x.
More positively, there are strong cash positions which ought to guarantee forecast dividends in the short term: Vertu having had nearly £68 million at end-February and Marshall’s £34 million end-of-last December.
Both must be trending higher although Vertu has historically had much stronger cash reserves.
It is somewhat tricky for boards to judge how to deploy cash – as material dividend growth might not be sustainable and acquisitions seem likely currently to be pricey. Vertu has not acquired materially since last December and Marshall’s since December 2019.
Vertu Motors - financial summary
Year end 28 Feb
|Turnover (£ million)||2,423||2,823||2,796||2,982||3,065||2,548|
|Operating margin (%)||1.1||1.1||1.2||1.0||0.5||1.2|
|Operating profit (£m)||27.2||32.1||32.3||29.0||16.5||31.6|
|Net profit (£m)||20.7||24.0||24.7||20.5||3.0||16.3|
|Reported EPS (p)||5.9||6.0||6.2||5.4||0.8||4.4|
|Normalised EPS (p)||5.9||6.0||5.6||4.4||4.6||4.3|
|Earnings per share growth (%)||22.7||2.1||-7.3||-22.4||6.4||-6.1|
|Price/earnings multiple (x)||10.7|
|Return on capital (%)||12.1||11.9||11.2||8.5||4.0||7.2|
|Operating cashflow/share (p)||16.2||12.6||4.8||13.3||5.2||20.0|
|Free cashflow/share (p)||10.2||5.1||-1.4||4.4||1.0||16.0|
|Dividend per share (p)||1.3||1.4||1.5||1.6||0.6||0.0|
|Covered by earnings (x)||4.6||4.3||4.1||3.4||1.3||0.0|
|Net debt (£m)||-23.1||-21.0||-19.3||0.3||125||95.6|
|Net assets/share (p)||58.0||62.3||68.9||73.8||71.7||76.3|
Source: historic company REFS and company accounts
Marshall Motor Holdings - financial summary
Year end 31 Dec
|Turnover (£ million)||1,233||1,860||2,232||2,187||2,276||2,154|
|Operating margin (%)||1.5||1.3||0.9||1.3||1.3||1.4|
|Operating profit (£m)||18.2||23.4||20.1||27.6||29.6||30.5|
|Net profit (£m)||11.7||17.8||49.4||14.0||15.6||13.9|
|Reported EPS (p)||19.7||17.7||11.9||16.6||19.7||17.4|
|Normalised EPS (p)||19.0||18.9||20.2||27.8||29.0||-16.4|
|Earnings per share growth (%)||48.6||-0.5||6.9||37.3||4.4|
|Return on capital (%)||10.9||10.8||8.9||9.1||8.9||9.0|
|Operating cashflow/share (p)||42.9||101||67.6||40.4||48.8||100|
|Free cashflow/share (p)||-23.7||23.1||-4.4||12.7||24.3||85.4|
|Dividend per share (p)||3.0||5.5||6.4||8.5||2.9||0.0|
|Covered by earnings (x)||6.6||3.2||1.9||2.0||6.9||0.0|
|Net debt (£m)||27.2||119||2.2||92.8||139||70.5|
|Net assets/share (p)||168||188||247||249||259||276|
Source: historic company REFS and company accounts
Vertu enjoys a modest discount to net tangible asset value
It has £276 million net assets, within which 37% constitute (chiefly) goodwill plus intangibles; hence it trades at a slight discount to net tangible assets of 47p a share.
£247 million property forms the bulk of non-current assets. Within working capital, there are nearly £600 million inventories versus £700 million trade payables (down 4% on February 2020) also £60 million trade creditors, £72 million bank debt and £77 million lease liabilities.
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So, assuming the high inventories/trade payables profile is managed well, Vertu’s balance sheet does offer good support.
Marshall’s is quite similar to Pendragon (LSE:PDG): trading at a 91% premium to net tangible assets per share of 123p. Of £216 million net assets, 55% constitute goodwill/intangibles and inventories of £363 million compare with £491 million, near-term trade payables.
Other liabilities comprise just £4 million bank debt albeit £99 lease liabilities.
Vertu therefore has an advantage by way of a slight margin of safety versus a conservative balance sheet view.
CIP Merchant Capital backed Vertu for its ‘omni-channel functionality’
This institution actually put out an RNS last May when taking a 0.42% stake, effectively saying this aspect of marketing is a competitive advantage that “puts Vertu in a strong position to benefit from the UK economy’s recovery phase”.
That the investment was outside CIP’s core target areas appears a tribute to Vertu’s credentials.
My conclusion is Vertu being the sector’s chief pick if you can stomach inherent uncertainty with the vehicles’ market.
In long-term context, the stock has yet to recover 2015’s high of 77p since when it trended down – briefly to around 18p in March 2020 – though had tested 100p in early 2007.
A private equity buyer might justify paying a 70p a share and still exact value, shareholders could be willing to accept for a 50%+ premium. Not a prediction just a possibility. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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