Invest-ability daily 14/10/21: Motoring Along

Booming used car sales have been good news for dealers, but watch out for traffic ahead

The business of selling cars has always had a rather unsavoury reputation. Some may argue it still does – only recently did the FCA ban a practice called ‘discretionary commission finance’ which has seen huge numbers of customers overcharged interest to boost dealer commissions. But it has arguably come a long way in the years since Arthur Daley types prowled the forecourts, and for consumers it has never been easier and safer to buy a car – and in that respect, the industry has never been healthier.

Although small dealerships still in exist in what remains a very fragmented industry, more and more of the trade is ending up in the hands of larger, often-listed networks powered by sophisticated sales and marketing machines and supported by a gigantic finance industry. Results from Vertu show this in action. It substantially upgraded its guidance after generating record profitability in the first six months of its financial year, threw off potloads of cash, and reinstated its dividend after the pandemic hiatus. People can’t resist a new motor, it seems, especially if they can get one on the never-never.

There has been, of course, a pent-up demand effect at play across the motor trade – car purchases don’t get cancelled, just postponed. And profits have had a tailwind from rising used car prices, the odd consequence of a semiconductor shortage causing bottlenecks in the manufacture of new cars. Nevertheless, Vertu has made hay while the sun has been shining, and that’s helped it get the balance sheet in a stronger position to keep consolidating – a virtuous circle as scale gives it operational advantages and property underpins its balance sheet.

But motor retail has always been a difficult industry to invest in, a tale told by simply looking at share prices across the sector – they remind me of navigating a single-lane Suffolk track at harvest time: lots of stopping and starting, a little bit of reversing, occasional bursts of speed and the odd crash. Vertu may have enjoyed a good harvest in 2021, but the sun may not shine quite as brightly next year. Indeed, car sales are cyclical to a degree, in that while people definitely need them purchases can be delayed if economic times look tough – as historic data from the Society of Motor Manufacturers and Traders shows, car sales go through their ups and downs as consumer confidences waxes and wanes.

And managing the mix between higher-margin used and aftersales business and lower-margin new and fleet business has always meant a consistent unreliability to profits across the industry. Indeed, a very profitable year selling second-hand cars may well be followed by a more difficult one next year if getting hold of stock becomes more difficult – which the lack of new cars sales in 2020 makes rather inevitable. A bounce-back in new car production may see demand swing back in their direction, but that could in fact dampen margins, especially if a weak pound hits pricing as it did in 2018. Aftersales should be a profitable steady eddy, but staffing shortages are biting this industry, too, in this case not enough mechanics.   

It’s a constant balancing act that Vertu is taking lots of actions to mitigate against, not least investing lots in training and rewarding its staff (which I like to see). It’s also invested lots in its e-commerce channels, but is up against disruptive challengers like Cazoo and Cinch whose arrival can only make an already ultra-low-margin industry even more competitive, as Phil recently discussed in his deep dive on Motorpoint. The average operating margin across the industry has settled to around 1.5 per cent. 

Unsurprisingly, Phil hasn’t been buying motor retailers but has instead bought into the UK’s love of a new car through Auto Trader, whose profitability is a little bit better than that. He’s explained his thinking behind the purchase in this week’s Quality Shares Weekly, but the short explanation is that the business appears largely immune to the industry trends that make life so tough for the dealers themselves – even if the quality of Suffolk’s single-track backroads means I’ll be back in the garage before too long.

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