Car lovers don’t want to hear it, but the motor trade has not been a fashionable sector of the stock market for a very long time. For a company to be a star, it has to be ‘the next big thing’, so investors looking to make a quick buck are not keen on companies going nowhere in particular. In other words, it’s explosive growth that adds sparkle to the portfolio rather than boring old dividends.
This means solid companies tend to be undervalued while risky companies that can spin a good yarn are often valued as if they were bound to be the next Microsoft.
Car dealers have consequently been the ugly duckling of the stock market, valued at a fraction of their sales and at low price/earnings ratios. P/E is a kind of measure of corporate horsepower; the higher it is, the greater the stock market thinks the value of a pound of profit a company is delivering is worth. Some companies have massive P/Es in the twenties, thirties and forties, while car dealers have been languishing at the bottom end of the scale. Lookers, for example, has an 8.7 P/E and Reg Vardy and Pendragon sported sub-10 P/Es last year.
However, stocks and shares are as fashion-orientated as the car business and that’s one of the reasons for the flurry of takeover activity in the motor retail sector. Car dealers have been rallying since mid-last year. Pendragon has gone from 300p to 500p and Lookers from 300p to 470p, with Reg Vardy popping up from a fiver to 820p. Only HR Owen has been on the slide, falling from 220p to 140p. (Prices at the time of writing).
Main reasons for the apparent change of fortunes are twofold: potential for consolidation within the industry and the thirst of private equity to find companies with potential for re-engineering. The first factor is obvious and the punch up over Reg Vardy is a clear signal that the sector is ripe for another round of takeovers and mergers. The private equity theme is a bit more obscure but just as influential.
In the old days private equity was called asset stripping, but in this day and age it goes under the banner of ‘venture capital.’ The strategy is quite simple: get a trunk of cash from investors and find a company the market doesn’t like (for some fashion reason), yet has a large amount of sales and a solid business. Buy it on the cheap and then strip it of assets. It’s then put back on the market in a slim new format with a nice new lick of paint. Fortunes extracted, your investors are keen to give you more to repeat the trick.
This little earner has become so popular that there aren’t as many fat, sleepy big companies to render down as there were. So the game has changed and now the businesses being stalked are ones with massive sales but little market capitalisation - that is to say businesses selling loads but not valued at much. The plan is that with a big enough business, smart young managers can be brought in to improve margins.
Car dealerships are a perfect example of this. Let’s compare Lookers with GlaxoSmithKline, the pharmaceutical company: pound for pound, the stock market values GSK’s sales 28 times more highly than a pound of car sales at Lookers.
Now perhaps a difference of two or three hundred per cent might not look too amazing, but 2,800% - that smells like undervaluation. Because car retailers have vast sales for low valuation and the herd of old-style corporate prey has shrunk over recent years, it is inevitable that dealerships are going to be in the spotlight. Whether they are taking each other over or getting snapped up by ‘private equity’, the coming year or two will be an interesting one for the motor retail sector as the stock market players make their bets.