CAR: A high flyer living up to the name

In September last year I wrote an article about Car (ASX:CAR) where I asked the question, ‘could they continue to compound their growth?’ and pointed out that ‘ a lot will hinge on their ability to expand profitably in overseas markets.’ Exactly 14 months later, the share price has increased by 43%. Pro-forma revenue grew by 17%, of which 59% is now derived from outside Australia. Underlying profit also increased by 24%.

The premise of the previous article was that CAR was a high quality business that had demonstrated an ability to compound growth over many years. This was confirmed by its qualification for the Quality Compounder screen as presented by Stockopedia contributor Roland Head in his article Building a screen to find Compounding Quality stocks. CAR no longer meets the criteria for this screen as shown in the table below, although it only misses out on three areas which we will examine below.

* includes an abnormal gain.

The operating margin TTM of 95% for FY23 as reported in Stockopedia includes a one-off gain associated with moving to majority ownership of the US and Brazil businesses. This is not a situation that is likely to be repeated, however it does reflect very prudent investment decisions in the past. If that gain and other one- off costs were to be removed, the operating margin would have been 48%. Likewise the net margin TTM for FY23 of 82.6% drops to 35.6%.

Turning to the three areas where the criteria have been missed. Return on Capital Employed (ROCE) recorded its worst level in recent years and continued a downward trend.

Stockopedia does not use adjusted returns when calculating ROCE to avoid the situation where management may be tempted to adjust away unfavourable outcomes. This may make the measure more volatile but is a true reflection of the returns that have been earned. The declining returns are more a reflection of the expanding asset base than the earnings. Total assets have increased by a factor of almost five times over the last four years. As the asset base increases it becomes increasingly difficult to earn returns above 18%.

As the asset base has increased, so too have borrowings, resulting in a higher interest bill. This has pushed the interest cover below the threshold.

Turning to the positive side, the Quality Score has soared to 99. This reflects the strong Health Trend at 8 out of 9, the consistent profitability, good cash flow and solid balance sheet. Whilst debt has increased to fund the international expansion, it is still at quite conservative levels with net gearing of 36%.

Turning to the StockRanks, CAR displays the typical characteristics of a High Flyer. In terms of Quality and Momentum it couldn’t get much better, but as is often the case, the market is well aware that this is a high quality growth stock and has priced it accordingly, leading to a low value score. It trades at a PE ratio above 40 and has a dividend yield of about 2%. Dividends are 50% franked due to the fact that 48% of EBITDA is now earned outside Australia.

CAR operate the leading marketplace in each of the four markets where they operate. They are particularly dominant in Australia as well as Korea.

FY24 Full year results presentation, 12/8/24

The strongest growth engine in recent times has been in Latin America. They have operations in Brazil and Chile and recently closed their Mexican operation. EBITDA margins in Latin America improved 2.1% in FY24 but at 36.4% are well below Australia at 65% and North America at 60%. If they are able to grow their market share further in those markets they are likely to attain scale benefits and increase their margins. Initiatives in this area include expanding outside the key cities of Sao Paulo and Rio, investing in media operations and a financing partnership with Santander Bank to help buyers access finance.

Despite their dominant position in the market, they have a well honed playbook for driving efficiencies and growth. This includes increased digitisation of the whole vehicle transaction experience, including secure transfer of funds. They are also looking to increase their penetration in international markets further.

They steer clear of giving specific outlook targets, rather saying they expect good growth, strong growth or solid growth across their different markets. The market is forecasting revenue growth of 11% and underlying EPS growth of 7%. At the AGM in late October they stated they were performing well and on track.

Returning to the question posed in the opening paragraph, CAR have continued to grow. That growth has been strongest in the international markets, although Australia has still made a strong contribution of 13% revenue and profit growth and off an already high base. There still appears to be plenty of room for further growth, particularly in the overseas markets. That said, it is becoming more difficult, as reflected by their falling out of the quality compounders screen, as it gets harder to earn a high return on each incremental dollar invested.