Join our community of smart investors
OPINION

Priced to motor

Priced to motor
September 6, 2016
Priced to motor

Furthermore, pre-close trading updates in the past week have more than justified those share price gains as both companies are well on track to report record financial results. Of course, looking through the rear view window at trading activity before the EU Referendum is one thing, but it’s what has happened since then that’s important for the road ahead.

Bearing this in mind, the economic slowdown many economists had predicted has failed to materialise post the EU Referendum, so much so that the UK retail sales figures for July have confounded the sceptics who predicted consumers would rein in spending. In fact, growth of 1.4 per cent in the month suggests the referendum result had a negligible impact on household purchases in the short term at least. And there appears to have been an improvement in consumer confidence in August based on the GfK consumer confidence index. Businesses have been in a more positive frame of mind too as the Markit/CIPS purchasing managers' index (PMI) for August showed activity in UK services recorded the biggest month-on-month rise in the survey's history.

I would also flag up that Vertu’s business has “not experienced any significant change in consumer behaviour”. True, lower margin private new registrations have been softening since April against near record numbers last year, but it’s the much higher margin used car sales and after sales that are the key growth drivers of the business. Trading here has proved resilient. I would flag up that after a small dip in used car prices in June, possibly reflecting consumer uncertainty in the run up to the EU Referendum, residual prices bounced back in July, according to British Car Auctions. That’s clearly good news for higher margin used car sales for auto dealers like Vertu and Cambria.

So, after taking the current trading outlook into consideration, and factoring in the contribution from the 12 volume and four premium outlets acquired in the past 12 months, I feel comfortable with forecasts from analyst Mike Allen at joint house broker Zeus Capital. Mr Allen predicts Vertu’s pre-tax profits will rise from £17m to £19m in the six months to end August 2016, delivering more than 60 per cent of his full-year pre-tax profit estimate of £31.5m, up from £27.4m on the prior year.

Interestingly, given the scope for operational improvements to drive incremental returns as Vertu integrates a number of acquisitions, Mr Allen makes the important point that although “we accept that trading conditions may soften from here, we believe our forecasts are increasingly conservative”. I wholeheartedly agree. I also feel that as a proven industry consolidator and one with a robust balance sheet, the risk:reward here is heavily skewed to the upside.

For instance, 84 per cent of Vertu’s share price is backed by hard assets as the company owns freehold and leasehold property worth £158m, or 39p a share, and has net funds of about £12m, or 3p a share. The shares are also trading on a hefty discount to year-end net asset value estimates in excess of 60p. In terms of earnings, expect EPS of 6.1p for the 12 months to end February 2017, implying a forward PE ratio of 8. But that only tells part of the story, as cash profits are expected to rise by £5m to £39.6m in the 12 month period, so Vertu’s enterprise value (market value less net funds) equates to only 4.5 times its likely cash profits, one of the lowest ratings in the sector. A 2.8 per cent prospective dividend yield is decent too.

So, ahead of interim results on Wednesday, 12 October, I continue to rate Vertu’s shares a decent recovery buy at 50p, albeit one that still has some way to go to get back to the 66p level at which I initiated coverage 12 months ago ('Poised for a strong rally', 6 Sep 2015), or the 79p nine-year high hit in early January 2016.

Cambria undervalued

The investment case for smaller rival Cambria is equally strong. When I initiated coverage on the shares last summer at 57.5p ('Drive a re-rating', 13 Jul 2015), a key bull point was Cambria's management team’s enviable track record of buying underperforming dealerships and turning them round. They have proved adept at buying premium dealerships which offer a sound strategic fit too.

Acquired Jaguar Land Rover businesses in Barnet and North London, and Land Rover dealerships in Welwyn Garden City and Swindon, have been immediately earnings enhancing and in keeping with the board’s strategy to enhance a brand portfolio of 31 luxury, premium and volume dealerships with geographical representation spanning from the North West to the South East in Kent. These businesses are autonomous and trade under local brand names, including Dees, Doves, Grange, Invicta, Motorparks and Pure Triumph.

The combination of upside from acquisitions and a solid performance from the existing dealerships explains why analysts predict Cambria’s revenues should accelerate from £526m to £626m in the financial year just ended. On this basis, expect pre-tax profits to rise by over a third to £10.4m to deliver EPS of 8.2p. The respective forecasts for the 12 months to end August 2017 are for revenues of £709m, pre-tax profits of £12.1m and EPS of 9.5p, estimates that factor in the full 12 month benefits of those prior acquisitions. This means that Cambria’s shares are rated on seven times earnings estimates and offer a forward dividend yield of 1.3 per cent. The company is also attractively priced on an enterprise value basis at 5.5 times likely cash profits for the financial year just ended, falling to 4.8 times in the 12 months to end August 2017, assuming of course the resilience in trading post the EU referendum is maintained.

I see few reasons to suggest why this shouldn’t be the case. Indeed, the macro-economic environment of historically low interest rates and record high levels of employment in the UK provides a favourable economic backdrop for the sector. Although weaker exchange rate levels for sterling create uncertainty around future manufacturer strategies towards new car pricing, it’s well worth pointing out that European car makers were more than happy to sell heavily into the UK at exchange rates below the current cross rate of £1:€1.19 for most of 2011 and 2013. Furthermore, if the UK economy proves more resilient than most economists had predicted it would post the EU referendum, and I certainly feel the pessimists have got this one wrong, then it makes sense for the big car makers to maintain a strong presence in a market that’s still enjoying high levels of sales.

So, ahead of Cambria’s full-year results on Tuesday, 22 November, and with 32 per cent upside to my target price of 95p, I rate the shares a buy at 72p.

Oakley finds a new partner

Shares in car dealers are not the only ones on my watchlist worth keeping an eye on. Aim-traded private equity investment company Oakley Capital Investments (OCL:145p) has just announced a major asset sale and one that has significantly increased its net asset value per share.

The private equity funds Oakley invests in have sold a controlling stake in Parship Elite, Europe's leading online dating business, for an enterprise value of €300m (£252m). To put this price into some perspective, it equates to a 150 per cent internal rate of return on Oakley’s capital in the 16 month holding period since it invested in Parship, and a thumping cash return of 2.3 times its capital invested. The transaction values Oakley’s indirect economic interest in Parship at €67m (£56.3m), or £25m above the carrying value on 31 December 2015. Based on 190m shares in issue, that valuation uplift equates to 13.1p a share increase on Oakley’s December 2015 net asset value of 200p, and adds 9.4p a share to Oakley’s recently announced half-year net asset value estimate of 212p to 215p.

It certainly makes sense for Oakley to retain a minority interest in Parship given the potential for further value creation. That’s because the business, which has more than 10m registered users and has been signing up 1m new registered users a year, has been benefiting from an increase in the number of single people, the popularity and growing acceptance of online dating, and the rise of consumer usage of mobile devices. These trends have enabled online dating companies to reach a wider and younger demographic, and drive up user engagement. They are also driving profits, with analysts at Liberum Capital forecasting 20 per cent annual cash profit growth for Parship this year and next.

Oakley will announce its half year results shortly and this disposal gives further weight to what is already a strong investment case and one that’s not priced in. That’s because given the company’s equity is only being valued at £275m, or a third below my minimum estimate of spot net asset value of £428m, or 225p a share. It could be as high as 229p a share because Oakley’s holding in newly listed media group Time Out Group (TMO:142p) has recovered more than half its post-IPO losses since the June half year end. The flotation of the globally recognised brand of city-based leisure magazines hit the stock market at the worst possible time when investors were in 'risk-off' mode in the run-up to the EU referendum, and in the immediate aftermath too. However, Time Out’s shares are just 5 per cent shy of their 150p float price, and the recovery has added 4p a share to Oakley’s end June 2016 net asset value. Oakley’s stake in Time Out is worth £85m and accounts for a fifth of the company’s net asset value.

Moreover, after factoring in the €44m cash proceeds from the Parship transaction, I estimate cash and interest receivables now account for 77p a share of Oakley’s top-end spot net asset value of 229p, so in effect its private equity portfolio, including a retained interest in Parship, and the holding in Time Out Group (TMO:142p) are being attributed a value of only 67p in Oakley's share price, or 56 per cent below their combined book value of 152p.

That's a huge share price discount for a company that posted a 33 per cent positive return on its investment portfolio in 2015, and has just made a 2.3 times cash return on its equity investment in Parship. True, Oakley’s shares are flat-lining on my recommended buy in price in my 2016 Bargain shares portfolio, but it would appear that investors are now warming to what I see as a clear cut investment opportunity. Buy.