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Motor retail shares are cheap for a reason

As new car sales contract, there are hidden risks for motor retail stocks this year
August 17, 2017

If cheap shares are what you’re after then car retailers fit the bill. But that could be the result of ongoing suspicion about a downturn in the UK motor market this year and beyond. As inflation rises, wages stagnate and credit markets look more precarious, there’s growing concern over how the car market will fare in the medium term. Some of this is directly related to the motor finance market, but other issues include the UK’s Brexit negotiations and how this will affect future trade arrangements for motor manufacturers, not to mention the forecast decline in industry-wide UK new car retail sales this year.

Most of the investable options on the London Stock Exchange are motor retailers – dealerships or parent owners of multiple dealerships. So when it comes to tackling risks associated with motor finance, there’s an argument to say the liability lies with the lender, not the retailer. But if lending via personal contract purchase deals, or PCPs as they are commonly known, dries up then retailers are still in for a tough time. According to the latest data, more than three-quarters of new cars sold in the UK are sold via PCP arrangements. This leaves customers with what they perceive to be manageable monthly payments over a certain timeframe – usually three years – at the end of which they are faced with a choice. Either hand the car back or start a new plan and trade the residual value of the existing vehicle in against a newer model. In many cases, the latter option is more popular, but a new trend is emerging – particularly in the US – for consumers to terminate their contract, hand the vehicle over and walk away for good. In the UK, as inflation climbs and household budgets come under increasing pressure, this is becoming a more viable option too.

 

From the recent round of motor retail results, it’s clear to see that new car sales are, indeed, under pressure. As the new car retail market contracted by 4.8 per cent during the first six months of 2017, new car sales shrank for a number of retailers. At Pendragon (PDG), new car sales fell 4.3 per cent on a like-for-like basis during the first half, while over at Cambria (CAMB) new vehicle unit sales were down 12.4 per cent over the six months ended 28 February 2017. As part of a recent annual management statement, Vertu Motors (VTU) also admitted that market conditions for new vehicles had softened since March, once new vehicle excise duties came into effect. Others have been more resilient. Marshall Motor (MMH) managed to keep new car volumes fairly flat thanks to an aggressive stocking policy and reliance on premium brands – namely the German manufacturers and Jaguar Land Rover. Similarly, new car sales were good for Lookers (LOOK), up 7 per cent on a like-for-like basis during the first half.

But new car sales aren’t the only problem. The knock-on effect of a potential sales slowdown is a higher number of new and nearly-new cars flooding the market. This has consequences as far as residual values are concerned, which hurts retailers' margins when they are forced to keep prices competitive to shift stock. But Robin Gregson, Lookers’ chief financial officer, is trying to remain optimistic. So far, he says, residual values are holding up – particularly when it comes to early warning signs like car auctions. As long as this continues to be the case, margins on used cars should remain robust. What’s more, around two-thirds of Lookers’ profits are derived from used cars and aftersales – the latter of which is typically higher margin.