Used-car margins a vice for Vertu

It’s clear that the market for new cars has entered a period of contraction. The 4.4 per cent growth in new car registrations in March was only supported by a pull forward in demand ahead of increases in Vehicle Excise Duty in April. The following months saw demand drop off significantly, resulting in new registrations dropping 6.1 per cent year on year between March and June. In addition, Vertu’s management says tougher trading is the result of wider macro uncertainty and sterling's depreciation, which has seen input costs rise. Most worrying is the slide in used car margins, a specific problem among the group’s premium brands where prices are coming under more scrutiny by cash-strapped customers. It’s worrying because, at the latest count in May, used car and aftermarket sales underpinned Vertu’s profits, driven by volume growth and, crucially, “stable margins”.

These problems might even escalate should the car finance market begin to crumble, as many analysts fear it could once the Financial Conduct Authority, the regulator for financial services, becomes fully involved. If customers can't get the same funding for a new – or even a used – car as easily, prices will have to become even more competitive, which puts motor retailers’ profits at further risk.

There’s a wider issue to do with a possible diesel scrappage scheme in the UK, too. This would see the government incentivise customers to switch their cars to more environmentally-friendly models. While this might lead to a short-term sales boost for motor retailers, it could also leave them with a sizeable write-down on obsolete stock.

Admittedly, there are bright spots to be found in Vertu’s recent trading. Aftersales continue to grow and a small share buyback has been announced. Management also says it still expects that profits for the current financial year will be in line with market expectations and there has been no material change to consensus forecasts yet. There is lots of asset backing supporting the share price, too (see table), thanks to Vertu's freehold property portfolio, and a couple of planned disposals that could generate a £7m cash windfall this year.

But a blow could come in the form of working capital commitments. There is some analyst concern regarding Vertu's limited levels of free cash flow as a result of an intense capital expenditure programme across its retail estate. In 2016-17, cash conversion fell from 242 per cent of operating profit to 181 per cent, while operating cash inflows fell 12 per cent to £58.1m.