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Gear up with two auto related small cap stocks

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I reckon there are three types of homeowners when property prices rise:

  1. The bores, who go on endlessly about their property’s value. At every opportunity, they talk about their increase in wealth, even though it’s on paper and usually overlooks transaction costs, interest payments and money spent on home renovations and maintenance.
  2. The sensible types, who know their property gains are illusory. They have no intention of selling and would have to pay more for another house if they did.
  3. Finally, the spenders, who view rising property prices as a licence to borrow more money, renovate their home or buy home-related goods.

Expect more of the third category in the next 12 months – the spenders who drive the “wealth effect” from rising house prices. Simply, people feel wealthier so spend extra. That’s good for auto-related stocks as some homeowners use rising house prices to justify a new or used car.

To recap, I am bullish on house prices over the next three years. With interest rates at record lows and likely to stay there for a few years at least, property prices will rise. Gains of 10-20% in national house prices over that period would not surprise.

More economists are winding back their forecasts for large peak-to-trough falls in house prices, issued during the COVID-19 pandemic, and changing to positive price-gain forecasts. It looks like the national property prices bottomed in October and have turned a little higher.

However, talk of a property boom is premature. Many headwinds remain, notably high unemployment and the ending of Federal government wage subsidies in March 2020. Not to mention the lingering effect of COVID-19 on economic activity and risk of breakouts.

Last week, I nominated Stockland (SGP) as the best way to play a residential property recovery and have this year identified several housing-related stocks, such as Nick Scali (NCK).

Earlier this year, I outlined a bullish contrarian view on the big-four bank stocks and continue to believe they are a good buy, even after the sector’s strong share-price gains this month. The banks have further to run over the next months and will take the Australian share market higher with them.

I’m adding auto-related stocks to that list. My two favoured auto stocks, Carsales.com (CAR) and parts-provider Bapcor (BAP), have rallied this year. Smaller auto retailers Autosports Group (ASG) and MotorCycle Holdings (MTO) are also worth following.

What a difference 12 months makes. This time last year, auto stocks were being crushed after 20 consecutive monthly declines in new-vehicle sales. The November 2019 performance was the worst since November 2008 amid falling confidence and a “consumer recession”.

Like most stocks, auto retailers and parts makers were smashed in March 2020 at the peak of the Coronavirus-induced sharemarket selloff. Their comeback since then is remarkable: Carsales.com has almost doubled from its March low to $20.60.

Eagers Automotive (APE) has soared from about $3 in March to $13.46. Bapcor has more than doubled from its low this year to $7.26. The market is looking to a recovery in auto sales and parts demand, but has so far focused mostly on the big players.

Optimism is well founded. New-car sales last month were down just 1.5% compared to the same time a year earlier. Sales are still trending lower each month and are well down year-on-year. But the rate of falls is slowing, suggesting a gradual recovery is in sight.

Clearly, Federal government tax incentives on instant asset deprecation have helped, making it easier for tradies and other business owners to buy a work car.

Longer term, auto-related stocks could be big winners – or losers – from industry disruption. US stocks such as Carvana are making huge inroads by selling cars online. You buy the car online, Carvana delivers it, and picks it up for return within a week if you are unhappy with it.

Such disruption could transform car-retailing economics. Auto incumbents could reduce their reliance on costly showrooms and instead favour shopping-centre outlets, as Tesla does. This disruption could open the door for a new breed of auto competitors in Australia.

For now, the equation is much simpler: record-low interest rates for the next few years driving a house-price recovery and with that higher spending on home-related goods and cars.

Nobody should expect a rapid recovery in auto sales. But there’s enough to suggest a few small-cap auto stocks should have improving prospects next year. Here are two:

 

1. Autosports Group (ASG)

The owner of more than 40 new or used luxury-car dealerships listed on ASX in November 2016 through a $159-million IPO.

After briefly trading above the $2.40 issue price, Autosports has drifted lower in the past four years, hitting 54 cents at the peak of the March sharemarket sell-off. The shares have recovered to $1.41 but continue to disappoint investors in the IPO.

Autosports has had a rough few years. First, falling new-vehicle sales, which hurt all auto stocks. Then, extra weakness in luxury-car sales during the consumer recession last year. And this year, the effects of COVID-19 and temporary closure of its car dealerships.

Management admirably steered Autosports through COVID-19. Revenue was flat at $1.7 billion for FY20 after a sharp bounce back in trading in May and June. Autosports lost $104 million (NPAT) after writing down goodwill, but the result reinforced its earning resilience.

Autosports kept acquiring businesses through the pandemic, adding three Sydney dealerships.  Industry consolidation is a key growth driver for Autosports because the luxury-car dealership industry is fragmented with many smaller players that lack economies of scale.

At its Annual General Meeting last week, Autosports said the new-vehicle market in Queensland and New South Wales had steadily improved since April. The luxury-vehicle market was up 3 per cent in NSW and 1 per cent in Queensland in that period.

Victoria emerging from lockdown is another plus. About a fifth of Autosports’ revenue comes from the State. Dealership closures in Victoria took $7 million from its profit in FY20.

Autosports has issued guidance for the first half of FY21 ($20 million in net profit before tax). The company expects moderate revenue growth, strong new- and used-car profit margins, and the re-emergence of its Victorian business after the easing of Stage Four lockdowns.

The company could do a little better than the market expects. There will be pent-up demand from some wealthier consumers (who still have jobs) for a new or used luxury vehicle after COVID-19 and because of car-supply constraints, Autosports has a backlog of orders.

Moreover, a sharemarket that could test its previous high in the New Year and rising property prices in 2021 should be enough to spark a mild recovery in luxury-car sales.

Autosports has always had a lot of potential, but industry conditions have been against it in the past few years. As its outlook improves, gains should slowly improve from here.

 

Chart 1: Autosports (ASG)

Source: ASX
 

2. MotorCycle Holdings (MTO)

The motorcycle dealership listed on ASX through a $46-million IPO in April 2016 at $2 a share. It was a market darling for a time, soaring above $5 within two years of listing.

Then, like other dealerships, MotorCycle Holdings suffered from a weakening market for vehicle sales. Its shares plunged to almost 60 cents at the peak of the March sell-off.

MotorCycle Holdings has since rallied to $2.40 and gains have been especially strong in the past two months as the market bets on a recovery.

To recap, the company is Australia’s largest motorcycle dealership with 30 outlets. It has operated for more than three decades and its market share is reportedly 11%.

In a recent presentation, MotorCycle Holdings said interest in motorcycles has ramped up since COVID-19 and continues to be above FY20 levels. Demand for used bikes has been especially strong, but sales have been limited by stock availability, the company said.

Like Autosports, MotorCycle Holdings will benefit as Victoria reopens. The company maintained Victorian sales at half the normal rate and expects pent-up demand from consumers there.

Management says buoyant industry conditions will limit acquisition opportunities. Like Autosports, MotorCycle Holdings is consolidating a fragmented dealership industry.

Also like Autosports, it has issued profit guidance for the first half of FY21 – an excellent sign. MotorCycle Holdings expects to resume paying dividends.

After its rally in the past few months, MotorCycle Holdings’ share-price gains will be slower from here. But there’s a lot to like about the company’s outlook in the next few years as rising property and share prices add to demand for new and used bikes.

The company did a good job during COVID-19 managing costs and reducing debt, and looks well placed to benefit from better industry conditions next year.

Autosports look better value than MotorCycle Holding at the current price. Both stocks warrant a spot on portfolio watchlists for investors comfortable with the higher risks of owning small-cap companies that are consolidating their industry.
 

Chart 2: MotorCycle Holdings (MTO)

Source: ASX

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. All prices and analysis at 28 November 2020. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.