Car dealership Lookers (LON:LOOK) share price fell today as much as 25% as it declared that a reduction in new car registrations as well as a challenging environment would mean that profit for this year would fall below initial expectations.
The share price chart makes grim reading for holders:
Having straddled the 100p region for most of this year and the last, the shares were rocked last month by a decision by the FCA to investigate sales practices in the sector. Combined with today’s profit warning the share price now sits at a 10-year low.
The automotive sector is one of the cheapest ones to buy in currently. Other firms such as Vertu Motors, Pendragon, Marshall Motor Holdings all trade at very low multiples. The reasons for this are mainly structural: very thin margins, decreasing confidence in the economy and increased uncertainty as to what Brexit will bring. There is also the longer-term spectre of cars becoming electric and more reliable. Pendragon put out its own profit warning recently.
On the other hand, many if not all of these firms deliver consistent profits, and pay out money to their shareholders in terms of dividends. Many also have very strong balance sheets, with the property that their car dealerships sit on being large plots of land, some in attractive locations. Many have also moved into second-hand sales and servicing, activities which generate a much higher margin than retailing new cars.
The warning comes today as the company puts out its half-year trading update. Whilst the first half of the year has started positively, it does seem that things have rapidly changed:
Whilst the period began satisfactorily, trading during the three months ended 30 June 2019 (“Q2”), against strong comparatives, has proved increasingly more challenging. During Q2 the UK new car market continued to decline with registrations down -4.6% (Q1: -2.4%) versus the comparable period last year. In addition, weaker demand and the resulting margin pressure in the used car market has significantly increased, notably during the month of June in which we took a disciplined approach to managing stock.
I would assume a ‘disciplined’ approach means increasing discounts. This is quantified into numbers:
Throughout H1 and in line with general retail sector trends the Group has continued to experience cost inflation pressures.
As a result, underlying profit before tax for H1 is expected to be approximately £32m* compared to £43m* in the comparable period last year.
There is a note by the asterisks saying this is before a proposed amortisation so these figures could end up much smaller in a statutory sense: there are over £200m of intangibles on the balance sheet. The outlook is no better:
The Board now expects that the more recent challenging conditions are likely to continue into H2, exacerbated by continued weakness in consumer confidence in light of wider political and economic uncertainty, and further pressure on used car margins. There is also the possibility of new vehicle supply restrictions as new emissions regulations come into force during Q3. In addition, the retail sector cost inflation experienced in H1 is likely to continue to impact earnings during the second half of the year.
As a result of the above factors, the Board’s current outlook for underlying profit before tax for the full year is now below its previous expectations.
This ‘below’ is pretty material: according to a note on Research Tree, forecasts are now £55m against a previous target of £74m.
One thing that stands out on the business is the discount to book value: Stockopedia rates the net assets as worth £400m. The current market capitalisation of the whole company is something like £140m after todays profit warning, and even after assuming a value of £0 for the intangible assets the asset value is greater than this. In practice, with £1bn of cars on the balance sheet it would be impossible to liquidate these without pushing prices downward.
Also noticeable is the consistent profit at very low yields: typically the operating margins are between 1.5-2.5% for car dealerships. So we can see that any downturn in business has the potential to hurt them quite badly. We saw that during the last recession, when the Lookers share price was even lower than it was today.
There are some things to like about the business. Revenues have grown consistently over the past few years – turnover is on course to double inside of 6 years and there appears to be more growth on the cards, albeit at a much slower rate. Management seem competent and have managed the business well, their fees are not excessive at present. As with many car dealerships, their business is very mature and arguably safe from disruption. Pendragon among others are seeking the development of the new ‘car supermarkets’ which takes the dealerships downmarket further, but it remains to be seen whether this will be viable. In the meantime, many dealerships can gain a loyal following, particularly for the more lucrative parts and servicing.
Shareholders have been treated well here, very little dilution of shares. There has been a dividend which at the last count was 4p. Given the yield of over 10% and the fact that this costs the company £15m, it seems unlikely to be held and more likely to be watered down heavily.
Despite the profit numbers, this isn’t a particularly cash generative business. Capex levels are high, and likely to remain so as it costs significant sums to maintain properties. Note, there is also a fair sized pension liability.
The nature of the business will undoubtedly put some people off. Car dealerships are low-margin businesses and arguably relatively undifferentiated, the choice being driven more by what car a customer wants. They are relatively common enough that a different one is within driving distance.
That said, the share price has now fallen to levels not seen before, a long way under book value, and still under tangible book value. I do also believe that their net debts are not as bad as stated, with £336m of it being very short-term stocking loans although this still has an effect on the overall finance charge. From a point of view of business I think this is less relevant than the longer-term debt, and the firm still has plenty of headroom in this respect.
The macro picture is about as bad as it can get at the moment, but in terms of value I think there is a decent upside although you may have to wait a while for it. The recent FCA investigation into selling practices also adds an additional unknown to the proceedings.
So not an immediate prospect of a great return, but one worth a bit more research. 3/5.