Inchcape shares tumble despite strong profit growth

Auto-dealer Inchcape (INCH) is highly sensitive to car shortages, used vehicle prices and consumer demand. So far, though, things seem to be working in its favour. Organic revenue grew by 15 per cent in 2022, and adjusted profit before tax jumped by 50 per cent to £373mn. However, the shares dropped by 15 per cent in the wake of its results, suggesting the market is nervous about the “changeable” conditions flagged by management.

Inchcape is moving away from retail, and this process has been accelerated by the disposal of its top-performing Russian business. Nevertheless, growth in the retail division – now concentrated in the UK and Poland – was strong. Organic revenue growth reached 10 per cent and adjusted operating profit jumped by a third to £47.5mn. Management said the supply of new vehicles improved every quarter, and this helped to offset a reduction in used car prices. As of this year changes to the way in which manufacturers sell cars mean Inchcape will only recognise a handling fee rather than a vehicle's selling price, which will have a “negligible” impact on operating profit, but cut revenue by £200mn.

The distribution division – which generated over 70 per cent of group revenue in the period, and is significantly higher-margin – is now the focus. Helped by a big increase in new vehicle volumes in Europe, organic revenue growth reached 17 per cent and adjusted operating profit jumped by 48 per cent to £363mn. Management believes that new vehicle supply will continue to improve in 2023, which will “support a normalisation of order books”. 

All eyes are now on the integration of Latin America's biggest automotive distributor, Derco, which Inchcape bought for £1.3bn in January. It is obviously early days, but the transaction is expected to deliver annualised “recurring synergies” of at least £40mn, with most delivered by the end of 2024. Even before these kick in, management expects Derco to generate an operating margin “towards the top end of the range of a typical automotive distribution business” (5-7 per cent). 

Despite all the chopping and changing, Inchcape’s cash conversion sat at 92 per cent, which fed into free cash flow of £380mn. 

Nevertheless, we are nervous about the economic outlook and how this will affect demand for vehicles. Discretionary incomes and the cost of credit will loom large this year. It is also very early days with Derco, and we would like to gather a bit more evidence on how this massive acquisition will affect the group. Hold. 

Last IC View: Hold, 843p, 28 Jul 2022