Clearly, enough investors have concluded that the de-rating of the automotive sector was way overdone, hence the strong bounce back rally, a sentiment I share having advised buying into the listed UK car dealers last summer. In fact, shares in Aim-traded Cambria Automobiles (CAMB: 83p) have reacted very positively to a pre-close trading update ahead of interim results on Tuesday, 10 May 2016, and are now only down slightly on the 87p level when I last reiterated my buy advice (‘Motoring ahead’, 12 Jan 2016). It’s worth noting that the price is still 45 per cent up on my advised buy in price of 57.5p when I initiated coverage ('Drive a re-rating', 13 Jul 2015). Importantly, there are reasons to expect the rally to continue towards my 95p target price.
Economic back drop
As I stated in my column last week, a deflationary price environment, combined with a global growth scare and the forthcoming Brexit referendum on Thursday, 23 June 2016, make it highly unlikely that the Bank of England will raise base rate this year. Borrowers and consumers alike will therefore continue to benefit from record low interest rates and real wage growth. Indeed, the flattening of UK government bond yield curve has led to some enticing finance offerings for personal borrowers in both the unsecured and secured debt markets. Given that a large number of private car buyers have been using personal contract plans and unsecured car loans to fund the purchase of their vehicles, the ongoing availability of cheap credit should continue to be supportive of demand from this segment as long as consumers have security of employment.
I would also point out that the UK is strategically a very important importer of new cars from EU countries, something that has not been lost on German automotive manufacturers who account for a third of all new cars sold in the UK each year. True, sterling has lost 10 per cent of its value since last summer which erodes the profits to be earned by exporters to the UK. But as the fifth largest economy in the world, and with over 800,000 jobs in Germany alone dependent on the UK car sector, there is a huge dependence on maintaining exports to our important end market. In any case, the devaluation in sterling against the euro has only taken the single currency back to a cross rate last seen in September 2014, a time when the UK car sector was motoring ahead. So although I am far from complacent about the implications of a Brexit, I am also aware that major EU exporters to the UK simply can’t afford to walk away from such a lucrative source of earnings.
Growth prospects not priced in
Importantly, the potential valuation upside for some UK-listed car dealers is not yet in the price. Buoyed by some smart earnings accretive acquisitions, details of which I outlined in my January article, sales of Cambria’s new and used vehicles both rose by around 4 per cent in the company’s latest six month trading period with gross profit per unit sale on the rise too.
As a result analyst Mike Allen at brokerage Zeus Capital expects the company to lift its first half pre-tax profits from £3.3m to £4.2m and maintains that for the 12 months to end August 2016 Cambria should be able to drive both pre-tax profits and EPS up by around 30 per cent to £9.9m and 7.8p, respectively. This forecast is based on a 12.5 per cent rise in overall sales at Cambria’s 44 franchises, including a valuable contribution from high margin after sales. While only accounting for 11 per cent of the company’s revenues, this segment generates around two fifths of gross profits, reflecting a hefty gross margin of 42 per cent. It was therefore pleasing to see that profitability was up 4 per cent from the after sales segment in the latest six month trading period.
I feel comfortable with Zeus’ forecasts, and with good reason too given that Cambria’s board report that “the March new car order book is building well and expects the company to deliver another strong trading performance in this crucial month”. So, with the added benefit of a lowly geared balance sheet – Cambria’s forecast net debt of £7m at the August 2016 year-end is well within borrowing facilities of £37m and is backed by property assets worth in excess of £40m – I feel a forecast PE ratio of 10 is hardly exacting especially the board has the firepower to make further selective earnings enhancing bolt-on acquisitions.
Furthermore, with the benefit of robust cashflow generation, expect a 20 per cent hike in the payout per share to 0.9p at the year-end to follow last year’s 25 per cent increase, implying a prospective dividend yield of 1.1 per cent. In my book, Cambria’s shares are still worth buying on a bid-offer spread of 80p to 83p and I am comfortable with my 95p target price.
The virtue of Vertu
Shares in Vertu Motors (VTU: 71.75p), the sixth-largest car dealer in the UK, sold off from January’s eight year high of 79p to a low of 66p last month, the price at which I initiated coverage last autumn ('Poised for a strong rally', 6 Sep 2015). The fact that the share price has made up half of those paper losses is not only indicative of the fact that investors overreacted in the first place, but also reflects news that the board have been using the company’s cash rich balance sheet to make further earnings accretive acquisitions.
In fact, following the bolt-on acquisition of Aceparts, a well-established non-franchised online vehicle parts business (www.aceparts.com) headquartered in Sittingbourne, Kent ('In the fast lane', 2 December 2015), Vertu has just acquired three Mercedes dealerships in the Thames Valley region operating in Reading, Ascot and Slough, locations with excellent customer demographics. A third of the initial cash consideration of £18.2m is backed by freehold property worth £6.2m.
These three dealerships generated cash profits of £2.4m in 2015 and pre-tax profits of £1.2m based on revenues of £88m. The deal makes strategic sense as Vertu’s management team led by chief executive Robert Forrester, who established the company almost ten years ago, has a strong background with the Mercedes brands. After factoring in a 12-month earn-out of £3.5m, the total consideration equates to a cash profit multiple of nine times, a fair valuation in my view given that analyst Mike Allen at Zeus Capital believes that there is potential to boost cash profits to £4.5m over time, reflecting upside in both new and used car sales.
Impact on forecasts
The timing of the acquisition comes post the company’s financial year-end, so has no bearing on Zeus’s forecasts of pre-tax profits of £25.3m and EPS of 5.7p for the 12 months to end February 2016, representing earnings growth of almost 12 per cent. But it has led to a modest upgrade to the current financial year to end February 2017 when Zeus expects Vertu to grow revenues by 14 per cent to £2.7bn and deliver pre-tax profits of £29.7m and EPS of 6.6p. On this basis, the shares are rated on 11 times earnings estimates, a point higher than Cambria, even though £66m of Vertu’s market capitalisation of £266m is backed by property assets and it is expected to be in a net cash position of £5m at the end of last month. The sharp revenue growth reflects a spate of earnings enhancing bolt-on acquisitions Vertu has made since its August half-year end to deploy a £32.5m net cash pile at the time.
So with the company expected to report a bumper trading update later on this week ahead of full-year results in May, I feel that the 12 per cent earnings growth likely to be reported for the financial year just ended, and the 15 per cent EPS growth predicted in the current financial year, is still not reflected in a prospective PE ratio of 11. I also believe that investors are likely to warm to a near 25 per cent hike in the dividend to around 1.3p a share that’s likely to be declared by the board in the forthcoming results.
On a bid-offer spread of 71p to 71.75p, and offering decent upside to my fair value target range of 85p to 90p, I see a short-term trading buy opportunity here. Having last recommended buying the shares at 76p (‘Motoring ahead’, 12 January 2016), I feel that the odds favour the previous 79p share price high being targeted in the coming weeks. Buy.
MORE FROM SIMON THOMPSON...
I have written articles on the following 80 companies since the start of this year:
■ Grainger: Buy at 243.5p, target 280p; Dart: Take profits at 580p; Crystal Amber: Hold at 159p; Redde: Take profits at 203p; Burford Capital: Run profits at 196.5p; Renew Holdings: Run profits at 404p; Plethora Solutions: Speculative buy at 4.5p ('Stock check', 5 Jan 2016)
■ Elegant Hotels: Buy at 118p, target price 130p to 135p ('Check in for a profitable stay', 6 Jan 2016)
■ Safestyle: Run profits at 272p ahead of pre-close statement on 25 Jan 2016 ('Clear cut gains', 6 Jan 2016)
■ Epwin: Run profits at 143p, new target 170p ('Epwin on the acquisition trail', 6 Jan 2016)
■ GLI Finance: Recovery buy at 37.5p ('GLI shelves fundraise and its chief executive', 6 Jan 2016)
■ LXB Retail Properties: Buy at 97.5p, new six-month target 120p; Urban&Civic: Buy at 286.5p, target 325p; Conygar: Buy at 172p, target 200p ('Hot property, 7 Jan 2015)
■ Somero Enterprises: Buy at 139p, target 185p; 1pm: Buy at 70p, target 82p; First Property: Run profits at 53p; Avation: Buy at 145p, target 200p ('Small-cap value plays', 11 Jan 2016)
■ 32Red: Run profits at 147p; Netplay TV: Buy at 7p ('Chipping in', 12 Jan 2016)
■ Cambria Automobiles: Buy at 87p, new target 95p; Vertu Motors: Buy at 76p, target range 85p to 90p ('Motoring ahead', 12 Jan 2016)
■ Global Energy Development: Hold at 24p ('Cash rich, but unloved', 12 Jan 2016)
■ KBC Advanced Technologies: Bank profits and sell in the market at 183p ('Tech watch, 13 Jan 2015)
■ Sanderson: Buy at 75p, target range 85p to 90p ('Tech watch, 13 Jan 2015)
■ Trakm8: Buy at 300p, new target 400p ('Tech watch, 13 Jan 2015)
■ Amino Technologies: Buy at 120p, new target range 155p to 160p ('Amino has the ammunition', 14 Jan 2015)
■ easyHotels: Buy at 89p, initial target 100p ('easyHotels ramps up expansion', 14 Jan 2015)
■ Stanley Gibbons: Hold at 58p ('Stanley Gibbons fundraise', 14 Jan 2015)
■ Miton: Buy at 28p, target 35p; Moss Bros: Buy at 97p, target 120p to 130p; Bioquell: Buy at 140p, minimum target 170p; UTV Media: Trading buy at 184p ('An awesome foursome', 18 Jan 2015)
■ Equity market strategy ('Bear Market signals', 25 Jan 2015)
■ STM: Buy at 47p, target 80p; Stadium: Trading buy at 103p; Fairpoint: Run profits at 150p, target range 200p to 220p ('Exploiting market anomalies', 1 Feb 2015)
■ Character: Buy at 505p, target 600p; 1pm: Buy at 67p, target 82p; and Entu: Hold at 68p ('A trio of small-cap plays', 2 Feb 2016)
■ Inland: Buy at 83p; Henry Boot: Buy at 220p, target 260p; FTSE 350 housebuilding sector: Trading buy ('Playing the housing market', 3 Feb 2016)
■ Flowtech Fluidpower: Buy at 109p ('Undervalued and ripe for a re-rating', 4 Feb 2016)
■ Safestyle: Run profits at 253p ('Awaiting news on a cash return', 4 Feb 2016)
■ Bowleven; Volvere; French Connection; Bioquell; Juridica; Mind + Machines; Oakley Capital; Gresham House; Gresham House Strategic; Walker Crips ('Bargain shares', 4 Feb 2016)
■ AB Dynamics; Inspired Capital; H&T; Netplay TV; Mountview Estates; Crystal Amber; Arbuthnot Banking; Record; Pittards; Stanley Gibbons ('How the 2015 Bargain share portfolio fared', 4 Feb 2016)
■ IS Solutions: Buy at 120p, target 150p ('Big data, big profits', 8 February 2016)
■ 32Red: Run profits at 133p, easyHotel: Run profits at 99p; Burford Capital: Run profits at 230p; Bilby: Buy at 136.5p ('Hitting record highs', 9 February 2016)
■ BP Marsh & Partners : Buy at 157p, new target 190p ('Primed for investment gains', 10 February 2016)
■ Gama Aviation: Hold at 270p ('Gama hits guidance', 10 February 2016)
■ Bloomsbury Publishing: Buy at 150p, target range 175p to 185p ('Book into a trading play', 11 February 2016)
■ PV Crystalox Solar: Speculative buy at 8.2p ('Lights brighten at PV Crystalox Solar', 11 February 2016)
■ Alpha Real Trust: Buy at 80p, target 105p ('High yield property play', 15 February 2016)
■ LMS Capital: Buy at 68p; Leaf Clean Energy: Await news on Invenergy; Eurovestech: Sell at 7p ('Investment company watch', 16 February 2016)
■ GLI Finance: Buy at 31p ('GLI Finance review offers potential for gains', 17 February 2016)
■ Trifast: Buy at 112p, target 140p ('Engineered for a higher rating', 17 February 2016)
■ 600 Group: Sell at 10p ('600 Group warns', 17 February 2016)
■ Marwyn Value Investors: Buy at 190p ('Undervalued, cash rich investment, 18 February 2016)
■ Henry Boot: Buy at 220p; Moss Bros: Buy at 102p, target range 120p to 130p; Creston: Sell at 103p; Minds + Machines: Buy at 8.5p ('Changing places', 22 February 2016)
■ CareTech: Buy at 245p, target price 300p ('Asset backed, lowly rated property play', 23 February 2016)
■ WH Ireland: Buy at 90p, medium-term target 120p ('WH Ireland hit by FCA fine', 23 February 2016)
■ Stanley Gibbons: Sell at 44p ('Stanley Gibbons rescue equity raise', 23 February 2016)
■ Gresham House: Buy at 325p ('Gresham House spruces up forestry deal', 24 February 2016)
■ Avation: Buy at 140p ('Aircraft deliveries mask Avation's lift off', 24 February 2016)
■ Tristel: Take profits at 125p ('Investors spooked by bugbuster's sales slowdown', 24 February 2016)
■ Town Centre Securities: Buy at 305p, target price 350p ('Property income play with capital upside', 25 February 2016)
■ Capital & Regional: Buy at 60.25p, target 66.5p to 70p ('Short-term trading buy', 29 February 2016)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking
