Auto Trader’s market dominance drives cash flow

Having a near monopoly of a market is a good place for a business to be. Last year, 75 per cent of time spent on automotive classified sites was on Auto Trader (AUTO). This dominance allows the company to raises prices without much complaint and keep generating cash for its shareholders.

Car retailers pay to list cars on Auto Trader websites and there are three ways Auto Trader can monetise them. Retailers can list more cars on the website, but if they aren’t doing that, Auto Trader can increase the cost of listing or sell more expensive product packages. For example, there is the Market Extension product which allows retailers to sell outside their local area.

Last year, the number of retailers using the website was flat but Auto Trader managed to squeeze more money out of them by increasing prices and upselling more expensive products. Average revenue per retailer (ARPR) rose 10 per cent to £2,437. Next year, Auto Trader expects to be able to achieve another 10 per cent of ARPR growth through further price rises.

Auto Trader’s pricing power can be seen through its remarkably high 70 per cent operating margin. The overall group operating margin is 55 per cent because of the recently acquired lossmaking business Autorama. It does new vehicle leasing and recent supply chain issues meant new light commercial vehicles registrations were down 11 per cent last year, but management expects to reduce costs as Autorama is further integrated into the rest of the business.

The ability to grow around 10 per cent a year consistently coupled with a 70 per cent operating margin is appealing. Also, as Auto Trader is capital light it trades on a free cash flow yield of just 5 per cent. Broker Peel Hunt expects group operating margins to expand further as Autorama costs are reduced.

All of this combines to make Auto Trader a highly valued stock. Peel Hunt currently has it trading on a 2024 price/earnings ratio of 22 – not cheap but this rating seems fair given the strengths of the business. The only issue on the horizon is the UK’s ban on new internal combustion engines which could mean people hanging onto their cars for longer. But that's a while away and even then Auto Trader will be probably be the place to go for second hand electric vehicles. Hold. 

Last IC View: Hold, 574p, 11 Nov 2022