New car registrations fell by 1.1% in the UK in October, marking the end of a 43-month run of continuous growth. Figures from the Society of Motor Manufacturers and Traders (SMMT) show that since hitting a low of 1,941,253 cars registered in 2011, the new car market has grown by 27% to reach 2,475,435 units in 2014.
October’s decline was mainly in the private sector, where sales were 2.6% lower than at the same time last year. Retail sales are a key part of the business of big car retailers such as Vertu Motors, so should investors be concerned?
There’s been no market reaction to this slight decline and in my view this is correct. As I’ll explain, I think Vertu could still have more to offer.
Understanding the business
Car retailing is a cyclical business. At some point there will be a downturn. However, a closer look at Vertu’s business model suggests to me that we have not reached that point yet.
This is because while new car sales generate a lot of turnover, they don’t generate much profit. The table below is taken from Vertu’s latest interim results. Retail and fleet car sales accounted for just 29% of Vertu’s gross profit during the first half. Used car sales delivered a further 32% while aftersales made the largest single contribution over the period, with 38.8% of gross profit:
The reason for this is simple. Car manufacturers appear to keep most of the profit on new car sales for themselves. Look how low the gross margins are on all kinds of car sales: £1,142m of new and used sales only generated a gross profit of £80m. In contrast, £93.8m of aftersales generated £50.7m of gross profit.
Although it’s not a legal requirement, most new car buyers will have their car serviced at franchised dealers for the duration of the car’s warranty. This is the most reliable way to make certain that they don’t invalidate the car’s warranty or reduce its resale value.
Depending on the car manufacturer, that means 3-7 years of guaranteed high-margin aftersales work for the retailer. There’s also the likelihood that the car owner will come back to them for another new car at some point.
I suspect that Vertu is only just beginning to see the benefits of the new car boom in terms of increased levels of…
