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The rational investor in me refuses to buy expensive cars. Why spend many tens of thousands of dollars on a luxury model when a cheaper one does a similar job? Or worse, borrow to buy a depreciating asset or be locked into a long-term lease.
That’s boring, I know. And unusual. Sales of luxury cars in Australia soared in 2016, up 11% in a year. We bought more German-made cars than homegrown ones for the first time that year, when our car manufacturing industry was in its dying days.
The property boom was a tailwind for car sales. Many homeowners, particularly those in Sydney or Melbourne, upgraded their car to befit their new wealth status. Debt was cheap, banks eagerly lent and spending (paper) gains in your home’s value was a national pastime.
At the same time, luxury carmakers introduced cheaper models, making them more affordable for the masses. A boom in SUVs took hold and our congested roads were full of shiny new ones, bought mostly on credit. Population growth also boosted car sales.
Now, national house values are falling and a double-digit price correction from peak to trough is likely. Bank credit growth is slowing and more prudent lending practices after the Financial Services Royal Commission could stymie car lending and sales. Waning consumer sentiment is another headwind; new car purchases can be delayed when financial pressures build.
New car sales have fallen in six consecutive months to September 2018. Year-on-year, they were down 5.5%. Some veteran dealers I know say sales growth is much weaker than official figures suggest and conditions are the worst in many years, and deteriorating.
Consider how that plays out: car dealerships left with excess stock; sales people desperate to meet their budgets and earn commissions; larger price discounting needed to sell; and a greater risk of irrational behaviour from struggling dealerships.
The result: lower revenue growth, contracting margins, falling profits and possibly some insolvencies among smaller dealerships. Then there’s the risk of consumers delaying or avoiding servicing their car, an important revenue stream for many dealerships.
The market is well aware of these trends. Most car-related stocks are down sharply in the past 12 months. Car dealership leader, Automotive Holding Group, has a one-year total shareholder return of minus 50%. Car advertising giant, Carsales.com, is off 18%.
By my count, about three dozen ASX stocks are linked to the car industry. They include dealerships such as AHG, AP Eagers, Autosports Group and MotorCycle Holdings; online marketplaces such as Carsales.com; manufacturers; retailers; car technology companies; and rideshare services. There are even more if McMillan Shakespeare and other novated leasing and fleet management stocks are included.
Most automotive-related stocks on the ASX are too small and speculative for conservative investors. In my view, the best automotive opportunities are overseas in Bayerische Motoren Werke Aktiengesellschaft (BMW) and other luxury carmakers that are superbly positioned for growth in Asia and stronger growth in luxury retail in the region.
BMW is on a forward price-earnings (PE) multiple of just seven times, consensus estimates shows, and trading around 20% below the average analyst price target, after heavy price falls this year. Wealthy Asian consumers tend to prefer well-known global brands such as BMW, Mercedes-Benz and Audi, over local ones: witness the number of upmarket foreign brands appearing in Australian shopping centres to cater for this market.
In Australia, the key issue for automotive-related stocks is valuation. The downturn in car and motorbike sales has further to run as the property slowdown escalates, possibly another year or two. Much automotive consumption was brought forward during the boom years leading up to 2016, meaning many consumers are a long way from having to replace their vehicle.
But the market is pricing in too much gloom, at least for some large auto stocks. Australia’s strong population growth will help car sales, the economy is reasonably solid for now, unemployment is low and wages growth is starting to rise. The Reserve Bank forecasts above-trend economic growth (3.5%) for Australia over the next two years.
Interest rates are likely to remain low in 2019 and probably longer, and auto industry reports suggest plenty of new car launches and upgrades next year, which will attract people to showrooms and encourage trade-ins and upgrades.
Moreover, those who bought a new car during the boom years up to 2016 might need a replacement in the next few years (people on average keep their car for around six years, overseas research shows). Also, greater traffic congestion and longer commute times in capital cities means more wear and tear and, for some owners, shorter car replacement cycles.
So it’s not all bad news. The auto industry needs to get through this rough patch and position for an upswing when house prices stabilise, consumers feel more confident and have to upgrade the car they bought earlier this decade. A re-rating in auto stocks will occur before that happens, as the market looks forward to a recovery in car sales.
I favour Carsales.com and AHG at current prices. Smaller players Autosports Group and MotorCycle Holdings have attractions because they are consolidating fragmented industry segments through acquisitions. But both are unlikely to recover any time soon, as the downtrend in car and motorbike sales lingers.
Carsales.com and AHG both suit investors who have at least a medium-term view (one to three years) and can withstand ongoing short-term weakness in auto and potentially further price falls.
I understand investors avoiding housing-related sectors: companies exposed to housing construction, renovations, furnishings and other discretionary retail should mostly be avoided for now. The car sector is another casualty but price falls of 50% or more in some auto stocks over the past 12 months suggest it is time for contrarians to have a closer look.
Too many investors misunderstand the relationship between large online marketplaces and their sectors. Property prices are falling, so it’s time to sell REA Group, right? Wrong. The property advertising group can benefit, as vendors are forced to advertise houses for longer, provided listing volumes remain relatively stable. REA continues to perform well.
Carsales.com can also maintain reasonable earnings growth in a slowing market, as dealers spend more on attracting car leads and as its international operations grow quickly, off a low base. Weaker display advertising and growth in Carsales.com’s finance operations are headwinds, but the lower share price captures those and other operational challenges.
As I have written before, one of my best strategies over the years has been to buy the big portal stocks (Seek, REA and Carsales.com) during market corrections. These stock usually look expensive because they have terrific business models and growth prospects, so you have to watch for irrational market selling to buy them, or when they are caught up in sector-specific issues, such as the current sell-off in global tech stocks.
At $11.57, Carsales.com is on a PE multiple of about 20 times, consensus analyst estimates show. That is a significant discount to Carsales.com’s average annual PE of about 25 times over the past five years.
Carsales.com’s forward PE of 20 is not demanding for a company that consistently delivers a return on equity above 40% and has an exceptional market position and business model, and strong international growth potential.
Morningstar values Carsales.com at $14.50 a share. An average price target of $14.93, based on the consensus of 10 broking firms, also suggests Carsales.com is undervalued. An expected dividend yield of 4.2%, fully franked, is another attraction.
Chart 1: Carsales.com
2. Automotive Holdings Group
Australia’s biggest car dealer also looks interesting, after falling from a 52-week high of $3.87 to $1.74. The diversified automotive and logistics group has the size and scale to withstand the car industry downturn and snap up weakened competitors.
AHG offers a mix of brands, meaning it is well placed to capitalise on car launches and new models with upgraded technology, which stimulate demand and get buyers back into showrooms.
At $1.74, AHG is on a forecast PE multiple of 9.5 times, a significant discount to the broader share market. A fully franked yield of 6.9%, based on consensus analyst forecasts, is attractive, assuming AHG can hold its dividend.
A share price target of $2.36, based on the consensus of 10 broking firms, implies AGH is undervalued. The consensus view looks a touch too bullish: AGH is not a screaming buy in the short term, given the downturn in car sales, but there’s emerging value for experienced investors who know the best time to buy is usually when the market overreacts to bad news.
Perpetual and some other good judges have been lifting their stake in AHG over the past few months and rival AP Eagers also bought more shares last month, taking its stake to around 27%. AP Eagers continue to move up the AGH register without triggering a compulsory takeover bid under creep provisions in the Corporations Act.
HNA International’s termination in July of its agreement to buy AHG’s refrigerated logistics business, while disappointing, removes a layer of uncertainty over the stock. The withdrawn deal added to the gloom hovering over AHG, creating opportunity for contrarians.
Chart 2: Automotive Holdings Group