Stockwatch: Inspiration for long-term investors

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Stockwatch: Inspiration for long-term investors stockpicking car dealerships
Do car retailers represent long-term value? At 128p, Lookers (LOOK) shares are interesting after a plunge from about 180p this year, exacerbated by the Brexit vote which saw the price twice dip below 100p.

Yet the company has defied fears with strong interim results which beat expectations, and revealed a healthy order book for September with 60% of that month's sales target already achieved. The group reassured: "The UK new car market is expected to show modest growth during the rest of this year."

Brexit not main issue

Against the doom-mongering, July retail sales have turned out much stronger than expected and the car market looks well-supported. Even if the next two years do lead to a softening, Lookers management sees this as merely a bump in the road ahead. They assert fundamentally this is a growth industry due to a long-term correlation between growth of GDP, population and car sales.

While I'd be wary that car sales can resist any downturn, Lookers' five-year record shows they have flourished in the UK since the 2009 recession, which partly relates to attractive finance packages. The Bank of England deputy governor recently told the Radio Four Today programme he wants to take interest rates down again from 0.25%. The currency effect on imported car sales as sterling tests a three-year low against the euro remains to be seen.

Impressive numbers are aided by acquisitions, but also show like-for-like progressMind, there isn't much room for things to go awry, considering a group operating margin trending only just above 2% (see table below). The composition of sales is also changing, with notes to the 2015 results stating revenues as 50.3% new cars, 33.2% used cars and 16.5% aftersales/parts, however the parts division has just been sold and management anticipates better growth prospects in dealerships.

Impressive numbers are aided by acquisitions, but still reflect strong like-for-like progress and affirm Lookers' strategy to rationalise a fragmented industry of dealerships.

Interim adjusted pre-tax profit jumped 16% to £50.1 million on turnover up 34% to £2.34 million, with operational cash flow up 157% to £107.8 million helping net debt reduce from £161.7 million at the start of 2016 to £74.9 million at end-June.

Given £81.4 million debt is structured long-term, it would appear £120 million cash proceeds from selling the parts division are earmarked for further acquisitions, e.g. on 15 August the £55.4 million purchase of a Mercedes-Benz and Smart-car dealership across the West Midlands.

A further premium-branded car dealership is currently being acquired, expected to announce shortly.

Dividend boost reflects confidence

Significantly, the interim dividend is up 20% compared to a 73% increase over the last five financial years. The board would be unlikely to do this or plan to reduce earnings cover to 3.5 to 4.0 times unless genuinely confident. Even so, the prospective yield is only about 2.8%, i.e. not enough of a prop should earnings deteriorate.

If the link between GDP, population and car sales is proved, Lookers' drop is a 'buy' opportunitySuch a risk looks priced in, however: with the stock at 128p its forward price/earnings (PE) multiple is about 8 or lower, with near-term risk more likely on the upside given these results beat expectations. Interim earnings per share rose 17% to 9.44p versus a consensus of 16.0p for 2016 as a whole.

The context is Company REFS showing Lookers' annual average P/E having risen from 9.7 times in 2012 to about 15 in 2013/14, the stock up from 50p to 150p over this period, which shows market wariness a true "growth rating" is appropriate. But if the link between GDP, population and car sales is maintained and Lookers continues to successfully rationalise the industry, the drop on the five-year chart is a buying opportunity.

Look beyond recent volatility

It's easy to see the market's response to interims as an uninspiring verdict. After a 5p rise to 136p intra-day, the stock closed below 130p and has settled there. But it had risen about 40% in a few weeks after twice testing a 90p range, so there was bound to be an element of traders cashing in once the results were out.

The technical position in the stock therefore means sellers had the upper hand despite strong results. Fresh money would wonder "why bother?" as the market trend did not affirm upside. Admittedly, there hasn't been insider buying disclosed as yet, out of the closed period. But if you believe Brexit recessionary fears are overdone then the context is attractive to accumulate motor retailing stocks like this.

A UK recession would make strategic acquisitions more attractiveA peer company for comparison is Pendragon (PDG), which cautioned in its 2 August interim results that profit growth was slowing, possibly why sentiment to Lookers was also cautious at the time. While Pendragon is on a quite similar PE of about 8.5, its dividend yield is more supportive at 4.6% if with lower earnings cover of about 2.5 times. The earnings growth scenario is less inspiring though, with an 11% fall expected this year then about 5% growth in 2017. So Lookers possibly comes out ahead overall.

The chairman's outlook statement cites "significant investment we are making in upgrading our give us a competitive advantage and further improve our leadership in the sector" also "substantial headroom in our bank facilities" enabling "further strategic acquisitions at a time when there are significant consolidation opportunities within the sector."

A UK recession would enable such deals to be made more attractively, and if it doesn't happen then Lookers is already attractively priced. So all considered, the stock appears attractive for longer-term investors.

Lookers - financial summary Consensus estimates
year ended 31 Dec 2011 2012 2013 2014 2015 2016 2017
Turnover (£ million) 1,898 2,057 2,464 3,043 3,649    
IFRS3 pre-tax profit (£m) 31.4 34.3 43.9 59.2 62.8    
Normalised pre-tax profit (£m) 31.9 33.6 43.4 58.4 71.6 80.8 84.5
Operating margin (%) 2.3 2.2 2.2 2.3 2.3    
IFRS3 earnings/share (p) 6.4 6.7 9.1 11.8 12.6    
Normalised earnings/share (p) 6.5 6.5 9.0 11.6 14.8 16.0 16.8
Earnings per share growth (%) 10.5 -0.5 38.2 28.8 27.8 8.4 4.9
Price/earnings multiple (x)         8.7 8.1 7.7
Price/earnings-to-growth (x)         0.3 1.0 1.6
Cash flow/share (p) 5.9 7.3 9.7 8.9 8.3    
Capex/share (p) -0.4 3.4 1.0 2.6 7.1    
Dividends per share (p) 2.0 2.2 2.4 2.7 2.9 3.4 3.8
Yield (%)         2.2 2.6 2.9
Covered by earnings (x) 3.3 3.0 3.7 4.4 5.1 4.7 4.5
Net tangible assets per share (p) 35.1 32.8 36.0 36.3 35.2    
Source: Company REFS

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.