Understanding the car dealership market and what it means to Vertu Motors and Lookers

20th Aug '17 by Orangetree

7 comments 5808 reads

After falling 40%, do Vertu and Lookers signal a buy, or are something amidst that we haven’t discover?

Before you take a dive into these car dealership stocks, how about we look into the sector as a whole? Explore where the car dealership market is trending. Understand what is driving (financing) the car demand in the UK.

After that, you can decide if these stocks or the sector as a whole is worthy of investment.

Afterwards, we will explore the scenarios for both Vertu and Lookers by making assumptions on their future earnings. This will help us to avoid “value traps” set by the market.

A Macro Perspective

Here is a chart showing the level of new car registration in the UK:

Source: SMMT.co.uk.

One reason for achieving five years of unbroken growth is thanks to low oil prices.

Notice the rise in oil price, typically signal slow growth or bring about a decline in new car registration. But, that isn’t all. The way car financing has changed over the past decade has helped to boost demand.

PCP Financing, what’s all about?

With rents and mortgages rising and wages stagnating, how are people able to pay for cars upfront?

The solution PCP financing.

PCP stands for personal contract purchase and is a loan to help you get a car.

Here how it works:

You typically pay a 10% deposit on the value of the car. The amount you borrow depends on how much value is lost over 24 or 36 months. This means you don’t pay the full value of the car. Typical APRs are 4%-7%.

Example

Let's imagine you sign up for a PCP over three years to buy a car with a ticket price of £18,000. You put down a deposit of £2,000 and the finance company calculates that the car will be worth at least £8,000 after three years. Here's how that would look...

To 'borrow' the car you pay... Deposit: £2,000 Loan: £8,000 (£10,000-£2,000) plus interest Total: £10,000 plus interest

To buy the car you pay... Deposit: £2,000 Loan: £8,000 (£10,000-£2,000) plus interest Balloon payment: £8,000 Total: £18,000 plus interest

(P.S. The above is a typical example from…

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aflash

21st Aug '17

Chart agrees with you on LOOK.

Downtrend since June.

Support 1 =105p. Support 2 = 101p.

However 3 brokers issued Buys on Aug 16 results.

Price may hold around present levels until Oct 26 divi.

Well argued article.

Time will tell if you are correct.

I hold both.

Tks

smatthews1

Excellent article, good insight to the industry. You mention about them not experiencing a decline in revenue as they would be proactive with buying up franchises.

However I find this as a big negative, as its just a bit of a smokescreen to dampen the effect on any decline in the industry.

Not only would there bit additional costs involved but their margins notoriously thin any way, why would they do this? Surely their time would be better spend protecting that margin and improving it rather than costly expansion?

Sean

Orangetree

22nd Aug '17

For car dealerships, margins can't be protected because they have no competitive advantage on price. The sector is a price taker, not a price-setter.
The expansion strategy is the only way to increase profits. That worked out well until they experience a downturn.

If there is a downturn, the car dealers will feel the pain more than the manufacturers because they will be left with a mountain of leased-cars and most are no older than 3 to 4 years old.
Unless the government introduce another scrappage scheme.

Interesting timing although it's Ford rather than gov.

http://www.bbc.co.uk/news/business-41005208

rhomboid1

Given stock turnover of used cars is c.6 times a year price deflation is a headwind rather than a killer blow, the RV risk is with finance provider, normally a bank or manufacturer/bank JV Most dealers have small leasing arms compared to previous recessions, e.g. Marshalls only de-fleet around 2000 cars a year from their own leasing arm which is small potatoes.

They're price takers in some ways but quasi local monopolies in service as they tend to have Regional RMA's , so customers would need to be really keen to drive 50 miles to get their Franchise service stamp from a competitor

Zipmanpeter

2nd Sep '17

I agree new car sales are likely to stagnate/fall in next 2 years. However, I think the effects will be markedly more benign for the top 2nd hand dealers (who are also the main new car dealers) although the sector as a whole faces longer term challenges.

For the customer with a PCP deal ending, the assumption is at the margin, some will not renew (causing the drop in new car sales). Unless they stop having cars, they will then either i) they keep the car which ages but still needs aftersales/servicing etc or ii) sell. Dealers absolute cash margin on a nearly new (say 3 year old) used car are very good and will remain so even if used prices dip. They also do enough marketing to keep a good set of sales even as (as everywhere else) a lot of simple sales go completely online (somehow - not sure this model is fully worked yet).

The real pain will thus be felt further down the chain in independent dealers selling 3-9 year old cars and those not making much money from aftersales/servicing (which is easy to sell to those completing a PCP deal. Right at the bottom, a lot of the 6-12 year old cars (from before fuel economy became a big deal) will be so low in value they will be scrapped. (Personally, I sold a lovely 12year Volvo S40 on this calculation and bought a soul-less Ford something as a 2yr payout proposition on 12,000M miles driving pa). Govt actions will nudge this along - see diesel emissions. Net, bad time to be an Arthur Daley small lot car dealer.

Especially if interest rates go up at the same 5 year timeframe, a lot of dealer will close/sell out as independent petrol stations went over last 20 years. The best of these will be hovered up by the bigger groups who will then put into better back office functions/better financing deals and put even further pressures on the survivors. Net, the sector will consolidate quite sharply but with some winners (probably neutral for them on profit but picking up share and scale).

With this logic, we should look for the best 2nd hand dealers and those with margin enriching customer programmes. This is why I hold Vertu Motors (LON:VTU). Been a explicit consolidator for many years, deliverately levering its internal processes and scale by buying under-performing and retiring dealerships; been doing well selling second hand; with good second hand brands (Bristol Street Motors); and well invested in genuine consumer Marketing. Recently appointed senior Marketeer and driving innovations like MOT service plans (now 100K in operation from memory). Also benefits from property deals - an upside it seems to be squeezing out.

Actually, longer term risk to top dealer is the move to electric cars. Far fewer working parts will make them last much longer and require less high margin servicing, whilst technology will gradually reduce the number of accidents. But again favour the best funded garages since electronics required not oily rags to fix the in car theatre system!. Furthermore, electric cars battery needs will drive weight reductions favouring smaller cars for most people - proper 1-2 person commute cars - with Uber style auto-hailing taking others in cities out of the market altogether. But vanity will keep enough people still buying big show off cars to keep the dealer network going - hence the mutual investment by top dealer and manufacturers in fewer better showrooms.

So 5-10 years from now, maybe 50% fewer dealerships, the top 2-5 groups with x2 the share they have now in a much smaller value market. As stated, I see VTU as a (modest) winner within this restricted context so happy to hold a small amount whilst not willing to buy a lot despite apparent good value at current price.

Understanding the car dealership market and what it means to Vertu Motors and Lookers

A Macro Perspective

PCP Financing, what’s all about?

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Orangetree

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