Join our community of smart investors

Tap into the Auto Trader network

The group is the market leader for automotive classified sites
July 9, 2020

Auto Trader (AUTO) is an online advertising business that specialises in new and second-hand car sales. The cars are mostly supplied by retailers and a small proportion from other consumers – these are then advertised on its marketplace sales platform.

IC TIP: Buy at 525p
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points

Market leader in automotive classified sites

High-quality business model

Strengthening position during crisis

Adding services

Bear points

Coronavirus disruption

Car market is cyclical

It has a very smart business model and its competitive advantage is underpinned by the so-called ‘network effect’. The term describes a business with a service that becomes more valuable the more it is used. For Auto Trader, the more customers that visit its website, the more attractive it is to advertisers. This means more cars are advertised, which means that the marketplace becomes more extensive and more helpful for buyers. It is a self-fulfilling cycle, and much of the growing value is directed right back to the company in the form of higher profits and cash generation. 

Auto Trader’s dominant network squeezes out smaller ones and strengthens its own competitive position as it grows. Indeed, at the end of March it was nine times bigger than its next largest rival, compared with five times a year earlier. Accounting for three-quarters of the time spent by consumers on automotive platforms has other benefits too. The level of user activity has allowed AutoTrader to develop add-on services such as market intelligence and financing recommendations. 

The company is highly profitable and capital spending requirements are relatively low, given the digital nature of its marketplace platform. This is reflected in its bumper return on capital employed (ROCE), which was 55 per cent in the past 12 months based on FactSet data. ROCE is a quality indicator, which measures how effectively money invested in a business is turned into profit.

True, it is worth bearing in mind that the group was severely hit by coronavirus this year, especially in April and May, while its car retailer customers were closed and the company itself was lossmaking. This has depressed forecasts for 2021.

Management took a number of actions to protect its financial position following the outbreak of coronavirus, including suspending its share buyback and its final dividend. In April, it placed shares that raised gross proceeds of £186m. We do not think that this signalled weakness and the company has said the money will be used to take advantage of opportunities arising in the aftermath of the current crisis. Indeed, it does not seem close to breaching its banking covenants and pulled back its net debt by £39m to £282m in the year to the end of March 2020. 

Management has also been taking a long-term view with the support offered to clients, including measures on to cut ad rates. For its retailer customers, it provided free advertising during April and May while they were closed, followed by a 25 per cent discount in June. The trading environment has improved somewhat. In the first three weeks of June, the group said it had seen record levels of visitors, with cross-platform visits up by more than a quarter on the same period in 2019. Indeed, the group returned to full rates in July – but management deserves credit for taking steps to support the industry during the height of the crisis in the UK. The move is likely to have strengthened relationships. 

Potential investors should note, however, that the car market is cyclical. In the case of a recession, fewer people are likely to commit to a big-ticket purchase such as a car. But since the outbreak of coronavirus, fewer people are taking public transport for fear of contagion. Once offices reopen, it could be that more employees want to drive themselves to work rather than squeezing onto a crowded bus. 

Consumer magazine What Car? found that the UK’s new car market started to show early indications of a recovery following the easing of lockdown restrictions in June. Although sales were still almost down 35 per cent, compared with the same period last year, it still represented a significant improvement compared with the data from May – which showed sales were down 89 per cent against the same month in 2019. 

Auto Trader (AUTO)    
ORD PRICE:525pMARKET VALUE:£4.8bn  
TOUCH:525-526p12-MONTH HIGH:614pLOW:309p
FORWARD DIVIDEND YIELD:1.5%FORWARD PE RATIO:24  
NET ASSET VALUE:15.4p*NET DEBT:199%**  
Year to 31 MarTurnover (£m)Pre-tax profit (£m)***Earnings per share (p)***Dividend per share (p) 
201833021117.75.90 
201935523420.07.00 
202036925222.12.40 
2021***27816914.27.30 
2022***37626422.37.70 
 +35+56+57+5 
Normal market size:     
Beta:0.9    
*Includes intangible assets of £342m, or 37.2p a share
**Includes lease liabilities of £9.1m
***Peel Hunt forecasts, adjusted PTP and EPS figures