Edmond Jackson's Stockwatch: Pendragon

Do bullish statistics for UK retail spending, coupled with the Bank of England's declaration it will keep interest rates at 0.5% for three years, imply it is time to increase exposure to retailers?

A cynical view is the consumer upturn is based on money printing and George Osborne relying on a typically British blend of rising house prices and easy credit to boost the Tories' prospects at the next general election; so why not exploit this? Governor Mark Carney has made plain the medium-term scenario the Bank will underwrite.

UK car retailers in particular seem to be benefiting from attractive finance deals at a time when manufacturers are deploying more models here, while continental European motor markets are depressed.

The tricky aspect for cautious investors is shares having largely anticipated this upturn after several years of quantitative easing; there are also risks with policy-setters inflating "the bubble economy" again instead of tackling more directly the UK's low rates of savings and investment. At some point this could end in crisis.

Another view is the consumer priming being a necessary evil to spur the wider economy out of stagnation, to "escape velocity" in bankers' jargon. So there are different interpretations of the risks. Yet with Carney asserting a radical three-year agenda of low interest rates it implies a relatively prosperous story for some retailers continuing - so valuations may stretch upwards from fair to full.

That's the macro context and the FTSE SmallCap shares in Pendragon are a useful example of a micro issue - namely, in what circumstances should you regard a chart uptick as likely to presage further gains?

Despite Pendragon's firmly appreciating share price, a non-executive director appears to have taken the cynical view I have outlined, recently buying 200,000 shares at 24.35p at end-June just before the company went into its closed period.

Pendragon has risen from 7p at end-2011, although its share-price range in 2009 after the financial crisis was 1.35p to 34.8p - so the 30p level is not out of historic context and the 12-month forward price/earnings multiple looks a fair enough 12 times.

The current uptick is linked to news of rising car registrations and Pendragon's latest interim results, which showed a 24% jump in underlying pre-tax profit to £23.6 million, ahead of expectations. However this was principally the result of a 33% fall in net debt to £147.3 million reducing finance costs, whereas the operating margin was steady at 2% and revenues rose only 5% to £2015 million.

Can the top line improve or might this be another company currently improving its results via efficiencies or lower debt charges?

It appears Pendragon is tracking the wider UK new-car market, which in the first half of 2013 rose a substantial 10% over the same period last year and is projected to grow by 8% for 2013 overall. The subsidiaries involved are Stratstone.com for prestige brands, Evanshalshaw.com for volume brands and Quicks.co.uk for after-sales.

The private car market is outperforming volumes in 2007, before the financial crisis, and Pendragon management describes the retail market as its key opportunity, representing just under half of the total UK market, hence the company enjoying first-half sales of new retail cars up by 20% to £924.4 million, with used volumes up by 9% to £759. million.

The shortfall was mainly in after-sales, down by 5.8% to £154.8 million, trade/wholesale which slipped 3.3% to £104.5 million and contracts/leasing, down 39.3% albeit a small contribution of just £11.6 million. There are a few other strands to the group, which clearly has yet to fire on all cylinders and even a strong performance in retail sales can be compromised so that the group number doesn't quite smack of a growth share.

You might have thought after-sales services would have been more resilient in tough economic times, versus new car sales, as motor vehicles must have repairs and maintenance tests for licensing and insurance. Pendragon has sensibly targeted vehicles over three years old. Industry sources suggest the reason for a soft market is the number of cars of this age, on the road, has plateaued.

By contrast with the UK, the French car market has declined by 10.3%, Italy's by 7.9% and Spain's by 2.6%; only Belgium is growing like the UK, with a rise of 9.2%. So unless the eurozone can escape recession fairly soon it looks as if car makers will continue to prioritise the UK with product and offers; the low interest rate environment is set to prolong the buyers' party. It should also help the commercial-vehicle market if a steady wider economic recovery follows.

Valuing Pendragon is mostly about earnings as despite good cash-flow-per-share figures and undemanding capital spending needs, a dividend policy has only recently been reinstated and forecasts imply a prospective yield under 2% nearly twice covered by earnings. There are negative net tangible assets per share.

Forecasts look fairly cautious however, and could be upgraded in due course considering progress by the car market and interest rate expectations now set for three years. The shares are not an aggressive buy, but risk looks to be on the upside - and that probably applies to various other retailers currently.

For more information see pendragonplc.com.