Shares in car retailer Pendragon (LON:PDG) fell another 20% today as it warned that following a management review, losses were greater than anticipated. This comes hot on the heels of a profit warning of sorts on the 17th of April which stated that losses would be £10m greater than originally thought, and a review would be initiated. Today we see the results of the review. Clearly the share price was not impressed:
As we can expect, it has been a choppy ride for the car dealerships, and these share prices are well off the highs seen in 2016. We have reached a multi-year low of 17p in early trade, although the recent pattern over the last few years was a bit of bad news causes the share to crash, then it recovers only for another bit of bad news to take it to a lower low.
Pendragon really is a demonstration of a company which is cyclical, as spending on regular Joe cars can be seen to be a good barometer for the health of the economy. As businesses therefore, they are prone to large swings in profits which are (almost) outside of their control. An excerpt from their accounts reads:
Thin operating margins and large gearing is part and parcel of all car retailers it seems. When times are good there is money to be made, but when times become tougher their large cost base acts as a real drag on profits. And it could be said that times have not been worse for the industry. A drop in new car registrations, several scandals revolving around emissions have seen sales hit, and the future doesn’t look much brighter either with a no-deal Brexit looming which may give rise to tariffs.
That being said, the company has not been priced for failure, which suggests that the markets do think that some good times will return.
The warning comes in the RNS ‘Outcome of Financial and Operational Review’. Here we have a prediction for the full year:
n addition to the challenging market, FY19 performance is expected to be impacted further by certain internal operational challenges. As a result, the Board now expect Group underlying PBT for FY19 to be a small loss (pre the disposal of the US Motor group), with the first-half of FY19 expected to be significantly loss making ahead of returning to overall Group profitability for the second-half.
Pendragon presents its profits in different ways: underlying basically excludes anything irregular, which is quite convenient for them. Even on this metric the swing is bad, as 2018 had an underlying profit of £76.2m. Clearly there were many things excluded, as the non-underlying figure was a large loss.
The reasons for this have been helpfully summarised:
The change in expected performance versus FY18 is driven by five key factors:
· Notwithstanding encouraging growth in unit volumes, Car Store losses have accelerated in FY19 as detailed later;
· A significant increase in used car stock at the end of FY18 (£458m FY18 vs £372m FY17) resulted in an excess of stock held across the business. An accelerated programme during the second quarter will significantly reduce the level of aged, pre-reg and ex demonstrator stock (38% of used stock units as at 1/4/19);
· A number of one-off releases of provisions from the balance sheet in FY18 which will not be repeated during FY19;
· Lower than anticipated new car margins in order to achieve volume targets with lower levels of tactical registrations; and
· Increases in costs, particularly in aftersales.
And more helpfully, an action plan to negate these points. Whether management will be able to deliver on it remains to be seen.
The biggest eyebrow raiser was the discrepancy last year in underlying to non-underlying results. An impairment of £95.8m was the reason, , although a large pension contribution was also included here. Prior to this, results at the business were good, although the structure of it has meant there are many characteristics which has turned investors away. As a result, this sector is one of the cheapest to buy shares in, with no company attracting a real premium rating.
The bull case is pretty sound. People are not going to simply stop driving cars, and there will always be a demand for them. Pendragon (and others) have adapted to changing market conditions well by leveraging their dealerships to cover a whole host of services. Not only can one get new cars, they can also buy used cars, lease new or used cars and get after-service – therefore profiting at multiple stages of a cars life. Declining new car sales therefore could be offset by improved used sales, or leasing.
Additionally, Pendragon have expanded into other countries and also have developed Pinewood, a software based system which seeks to become a world-wide leader for the back-end of dealerships. They have also invested heavily into online car retailing, which seeks to offer something new. This part of the business is growing quickly, although as we can see is generating heavy losses.
This forms part of the bear case. Capital expenditure has been heavy, and outstripped cashflow by a long way in recent years:
This has not been done with borrowed money, as debt has remained relatively stable. But what is clear is that the company are selling off assets to pay for this. The US business is currently for sale and is predicted to bring in another $100m. Reducing the number of sites also then reduces the need for this level of capex. It is surprising how expensive this can be,especially the premium locations: the capex bill running to almost £4m for just one. By contrast the new Car Store models are quite light.
There appears ample room for more sales to generate more cash. As of last year, another £35.4m worth of land and property were up for sale from a total of £240.5m. This provides some great asset backing for the balance sheet, as these tend to be fairly liquid. There is a lot going on in the balance sheet, with plenty of action on inventories and receivables – which are the lifeblood of the business after all.
However, with net assets of £345m sales of property cannot go on forever and clearly the changes being sought out now rather than later. It will not be possible to keep on running the massive capex deficits.
The debt does present some worries. The interest cost of this was £24.8m last year, although most of this was interest due to vehicle manufacturers as opposed to the bank. There is also a reasonably sized pension deficit of £68m of which almost £13m was needed as a contribution. Dividends are also continuing so we can see there are many expenses to pick out. This being said, the show keeps on rolling on, and the company are spinning many plates at once.
There is a lot to consider here. Clearly there will be more transformation and Pendragon will be more online based, and its Pinewood division offers a chance for clean, recurring revenues without the need for the levels of capex seen in the past. Without these expenses, the car dealerships would be huge machines and would genuinely convert their profits into cash.
But it is fair to say that there will always be a level of capex required due to the nature of the product. The Car Store model requires extremely large premises with many staff. Additionally I would think this type of thing could be replicated by other car dealerships who could simply convert existing locations into a generic model.
There is a lot of business for the money here, and if the transformation plan works Pendragon could be on a much firmer footing. But this is a sector with plenty of headwinds and a limited upside. It is difficult to see any attracting a premium rating. In the case of Pendragon, many of its peers appear much better off and trade at bigger discounts to their book value. 2/5.