In fact, half year underlying pre-tax profits of £4.6m were a thumping 18 per cent ahead of the expectations of analyst Matthew McEachran at joint house broker N+1 Singer, and 10 per cent higher than Mike Allen at Zeus Capital had predicted. The outcome was also 40 per cent up on the same period in the prior financial year. Moreover, with the company reporting strong trading in the key registration plate change month of March which came after the February half year end, analysts at both broking houses have upgraded their full-year earnings estimates by around 5 per cent.
Zeus Capital now expects pre-tax profits in the 12 months to end August 2016 to rise by 35 per cent to £10.4m based on a 17 per cent hike in revenues to £618m to produce EPS of 8.2p and underpin a 12 per cent increase in the payout to 0.9p a share. N+1 Singer has similar forecasts. On this basis, the shares are priced on less than 10 times earnings estimates and offer a 1.1 per cent prospective dividend yield. Those estimates imply second half pre-tax profits of £5.8m which looks a pretty solid forecast considering Cambria posted £4.4m of second half profit last financial year, and the company will benefit from some smart looking earnings accretive acquisitions this time round as well as a strong tailwind in both used and new car sales. Indeed, profit per unit on used car sales rose by almost 10 per cent in the latest six month trading period and the rolling 12-monthly return on investment, as defined by the gross profit as a proportion of average stock levels, has shot up to an industry leading return of 148 per cent. Tight working capital management, and low stock turn rates, also mitigate risk from any weakness in used car prices.
Part of the strength in used car sales is down to the increased penetration of personal contract plans (PCP) in the new car market whereby car buyers now change their vehicle every three to four years driven by the term structure of these financing products. So with March registrations across the industry in excess of 500,000, their highest level since the change to bi-annual plate change in 1999, and industry experts predicting annual new car sales registrations will remain above the 2.6m unit level, then Cambria is set to benefit from not only higher profits from new registrations, but a solid stream of business from higher levels of used car sales as a result. And it’s not as if the company is chasing new car sales business at the expense of margin as average profit per unit rose by 15.4 per cent in the six months to end February, a combination of underlying sales growth and the upside from the more profitable upmarket dealerships acquired.
Solid cash generation, and asset backing
I would also flag up the robust cash conversion of the company in the period as Cambria generated cashflow of £9.9m from operating activities and ended the period with net funds of £300,000, reversing a net debt position six months earlier despite spending almost £10m on acquisitions after accounting for proceeds from disposals. A new £37m five-year banking facility provides ample headroom for further earnings-enhancing bolt-on acquisitions, in line with the strategy of the board, led by chief executive Mark Lavery, to aim to build the company into a £1bn turnover enterprise. Since being established a decade ago, Cambria has built up a portfolio of 30 luxury, premium and volume dealerships through acquisition including top end brands Aston Martin, Alfa Romeo, Jaguar, and Landrover. As a result the company has rock solid asset backing with freehold and leasehold property on the balance sheet worth 37p a share.
Of course, one of the reasons why car dealers are priced on a thumping earnings multiple discount to the general retail sector is due to the cyclicality of the industry and the risk of profits going into reverse if consumers rein in spending. In particular, the forthcoming EU Referendum is an obvious risk. The flip side is that if there is a Brexin vote to stay in the EU – financial markets suggest a 69 per cent possibility for this outcome even if market research polls forecast it will be far closer – then the economic risk subduing car dealers’ valuations is likely to unwind rapidly after the referendum on Thursday, 23 June and send share price soaring. Furthermore, with Cambria’s shares trading on a miserly 8.5 times earnings estimates for the 2017 financial year (August year-end), there is a case to be made that the Brexit risk premium is already embedded in the valuation.
The bottom line is that I feel that Cambria’s shares are woefully undervalued, trading on a single digit earnings multiple, and on a modest two times book value, an attractive valuation for a company that’s generating a return on equity in excess of 21 per cent and has just reported a very strong trading update. I also feel that the UK will vote to stay in the EU.
So having first advised buying Cambria’s shares last summer at 57.5p when I initiated coverage ('Drive a re-rating', 13 Jul 2015), and reiterated that advice when the price was 83p (‘Lowly rated car dealers motoring back’, 7 Mar 2016), I feel that my 95p target price is not unreasonable. It’s in line with N+1 Singer's target, but on a deep discount to Zeus Capital’s valuation range (117p on a discounted cash flow basis to a blue sky valuation of 158p).
On a bid-offer spread of 75p to 78p, valuing the company’s equity at £78m, I rate Cambria’s shares a buy.
Please note that I published another column yesterday which is also available on my IC homepage.
