Investing in a car dealership like a leveraged bet for a speculative investor. You can either make big profits or lose a lot of money, depending on their business cycle. Also, the sector to open to various car dealerships meaning it is super competitive.
This is a background post in understanding the fundamentals of car dealerships.
Today, I will look at two car dealers, one is Lookers and the other is Vertu Motors.
A super competitive sector
A super competitive sector often attracts too many competition and result in low margins. So, if you see a car dealership selling for over two times their net assets value, it is best to cash your investment out when times are good.
Margins are barely above 2%.
Graph 1: Vertu Cash Margin
Graph 2: Lookers Cash Margin
As you can see, a 1% drop in margin can cause a sudden drop in cash earnings.
Take Vertu’s net cash flow in 2017 of £49m, which is equivalent to 1.77% cash margin. A 1% drop means a loss of £28m in cash earnings, taking net cash earnings down to £21m.
Therefore, you must pay attention to the economy because any recession will trickle down and affect the car retail industry (due to their high price tag). Also, look at high unemployment, declining wages and tightening of credit to have a big impact in this sector. The last time that happened their share price collapsed by 90%!
Keep an eye on stock levels
We all know that cars value drop rather rapidly. In fact, they drop by 15%-30% in value per year, this depends on the brand. That’s why you need to keep an eye on car inventories.
Graph 3: Vertu and Lookers car inventories
The levels of stock, as % of sales, are steady for both companies at 18%-21%.
Beware of Capital Employed
Given the razor thin margins and high revenue, investors should always pay close attention to the utilisation of capital.
Because sometimes a company requires lots of capital to increase earnings.
Graph 4: Capital Turnover
Vertu Motors has an advantage over…
