Just over a year ago we reported that demand for shiny new automobiles was stagnating, while the used car market was booming. How times have changed. Demand for new cars in the UK has skyrocketed, while used car sales have stalled. In May, new car registrations rose 11 per cent year on year, marking 15 months of consecutive growth, and private demand jumped 30 per cent, pushing volumes above pre-recession levels. Already in 2013, the market has risen by more than 9 per cent and there looks to be plenty of gas left in the tank.
Now, that might seem odd given the economic uncertainty and depressing news from the blighted eurozone. But it's that weakness in mainland Europe that is fuelling the vehicle spending spree here and benefiting UK dealers. New car sales on the continent have plummeted, which means manufacturers, faced with significant oversupply, are directing their attention to Britain where the economy is healthier and confidence slowly rising.
This renaissance has translated into higher sales and profits for car dealerships and fuelled a re-rating of the sector. In February 2012, the UK's main listed dealerships, Inchcape (INCH), Lookers (LOOK), Pendragon (PDG) and Vertu Motors (VTU) traded on an average forward earnings multiple of less than nine. Share prices have surged more than 50 per cent since, yet that multiple is still a modest 12 times earnings.
And there's no sign of a slowdown, either. Vehicle manufacturers are showering UK consumers with dirt cheap financing deals (80 per cent of new cars are sold on finance), which are subsidised by their in-house banks. Clearly, that's tempting more of us to replace old cars with a brand new, more fuel-efficient set of wheels given that costs are often very similar. And, crucially, cheap finance means that cars can be sold at highly competitive monthly rates without knocking down the headline price, which would have a detrimental effect on the price tag of higher-margin used cars.
"It's the monthly payments buyers look at, and those have come down and that's due to the manufacturers," says Trevor Finn, chief executive of national car dealership Pendragon. Similarly, Vertu Motors boss Robert Forrester says there has "never been a better time to buy a new car because affordability is at its best". Of course, Mr Forrester has a vested interest here, but his claim chimes with what many other analysts and industry players are saying.
Louise Wallis, head of business development for the National Franchised Dealers Association (NFDA), acknowledges the low-cost finance deals, but also highlights a surge in personal contract purchases (PCP), where buyers pay a lower monthly fee for a set term. They then either return the car or pay off the outstanding balance at the end of the period. This is smart as it locks people into a buying cycle. NFDA figures show two-thirds of new cars on finance are sold through PCPs.
There are, of course, other factors driving the new car market. Having navigated the worst of the recession, some people are simply more confident now and ready to buy. Others have enough spare cash for a deposit on a car, but not enough for a house. Jonathan Visscher, a spokesman for the Society of Motor Manufacturers and Traders (SMMT), says vehicle technology has progressed quickly, too, so a new car will offer a huge jump in both efficiency and safety compared with one that's just five or six years old.
"You look at finance deals and quickly realise the difference between what you are paying on an old vehicle with poor fuel efficiency and what you could get with a new vehicle is significant," says Mr Visscher. "It helps that vehicle taxation is now based on carbon emissions."
The long and winding road
Last year, more than 2.04m new vehicles were registered in the UK, and the SMMT expects that will rise to between 2.1m and 2.2m in 2013. That's a huge improvement on the 1.8m vehicles registered in 2008, although shy of pre-recession levels of 2.4m. The industry, however, believes that peak was inflated and that a recovery to just under that level is more realistic. The SMMT predicts that the UK new car market will continue to accelerate for the next year or two, provided consumer confidence is stable, rising 3 per cent in 2013, and a little more slowly in 2014. And that, admits Mr Visscher, is a conservative estimate.
This growing stock of young cars bodes well for dealers, too. Buyers with new motors tend to be more loyal and use the same dealership for servicing and repairs. After-sales business is far more lucrative for dealers and makes up 50 per cent of profit on beefy margins of 30 to 40 per cent, compared with mid-single-digit margins on new cars and 10 per cent on used vehicles. "We describe the service business as a supertanker," explains Pendragon's Mr Finn. "It's a delayed reaction from new car sales, and moves slowly, but underpins the whole business."
The other long-term benefit of rising new car sales is that they will eventually boost the number of used cars on the market, of which there is currently a shortfall. Used car sales generally lag the new car market by three to four years, so there's a lot of potential for growth here, too.
Is the engine overheating?
It seems that the biggest threat to the UK sector would be economic improvement in Europe. "A significant uptake in European car sales would stop the finance coming through," warns Mr Finn. "As long as Europe does badly, UK car dealerships will do well." But is he losing sleep over this possibility? "No," he says, and understandably so. Few forecasters believe the European car industry is capable of a significant recovery for some years, given unresolved issues surrounding demand and overcapacity, especially among the French volume manufacturers.
There is scope for further consolidation in the market, too, which will be earnings-enhancing for dealerships. True, some groups such as Vertu and Lookers have been expanding already, but, overall, consolidation has been slow. The top 10 dealership groups only account for 21 per cent of sites in the UK. So, for the big guys there's plenty of room to grow, and in a business where net profit margins are ultra-thin - typically around 1 per cent - it's all about scale.
| Company | Ticker | Share price (p) | Market Cap (£m) | Share price change 1-yr (%) | Operating margin (%) | Forward PE ratio |
|---|---|---|---|---|---|---|
| Caffyns | CFYN | 390 | 10.9 | 2.6 | 9.9 | - |
| HR Owen | HRO | 112 | 26.3 | 81 | 1.4 | 18 |
| Inchcape | INCH | 507 | 2,365 | 56 | 4.3 | 12 |
| Lookers | LOOK | 105 | 407 | 75 | 2.3 | 13.6 |
| Pendragon | PDG | 24 | 340 | 71 | 1.9 | 10.8 |
| Vertu | AIM: VTU | 41 | 136 | 46 | 0.7 | 12.3 |
| Source: S&P Capital IQ | ||||||
IC VIEW:
True, the UK economic recovery is likely to be slow, but the new car market is in good shape and we're likely to see decent growth in this sector for the next year or two. What's more, given the scope for further growth as higher new car sales trickle into improved aftersales and used sales, an average forward PE ratio of 12 (excluding HR Owen) looks cheap in our view. Further consolidation will benefit the bigger players and improve industry-wide standards, too.
