Eroding margins for UK used car dealers, two consecutive years of falling new car sales and the spectre of a regulatory clampdown on car financing have led to renewed worries among investors in car retailers’ stocks. For Pendragon [PDG] and Lookers [LOOK], the UK’s top two dealerships by revenues after US-owned Sytner, the really bad news started last month.
In early June, Pendragon’s and Lookers’ stocks hit lows not seen since early 2010, when the auto market was still recovering from the financial crisis. The two companies now stand out in a troubled market for how their specific woes and market pressures have resulted in a bad ride for shareholders.
To understand how the companies reached this point, it’s necessary to take a look at how the post-crisis years shaped their fortunes. The years following the financial crisis turned out to be very prosperous for the UK car retail industry. From 2009 until car sales reached their peak in 2016, Pendragon’s operating profits increased by 77%, while they rose by 245% at Lookers. The numbers were buoyed by steady growth in car financing, particularly for products like contract hire and personal contract purchase (PCP), whereby retailers shoulder part of the risk from a vehicle’s declining value.
But just as recovering profits were pushing car retailers’ stocks back to pre-crisis levels – between 2012 and 2015, Pendragon’s share price more than doubled to 47p and Lookers’ increased fivefold to 185p – retail sales began to cool. Vehicles that had been financed and leased during previous years started returning to sellers’ forecourts in droves, pushing used car prices down.
Pendragon share price battered by overcapacity and departures
After seeing a 20% drop in profits in 2017, along with an increase in used car stock parked on its lots, Pendragon decided it could turn the inflow of second-hand vehicles into an opportunity. Then-CEO Trevor Finn decided to shed US franchises, review the brand mix and bolster its network of “car supermarkets”, a multi-brand, lower-cost retail model popularised by Motorpoint [MOTR].
But toward the end of 2018, with still no improvement in sight, Finn and chief financial officer Tim Holden said they would be leaving the company. They stepped down last March and were replaced by Mark Herbert and Mark Willis, respectively, who immediately launched a review of the group’s business.
When Herbert was appointed, independent retail analyst Nick Bubb surmised that the new CEO would be “cursing the legacy of his predecessor". The comment proved prescient. Three months later, Herbert and Willis announced their resignations due to what Liberum analysts reckoned was a “difference of opinion on the level of change required” for the company after the two executives were dealt a “very poor hand” by the previous management. Pendragon’s stock has since dropped by 40% to 13.80p as of 12 July’s market close.
Lookers: regulatory troubles
For Lookers, margin troubles – in March, JP Morgan cut its target price on the stock from 129p to 98p on “weaker used vehicle profitability” – have now been compounded by regulatory ones. On 25 June, the company notified investors that the Financial Conduct Authority, which over the past year has increased its scrutiny of so-called dealer-brokers, launched an investigation into sales practices at the group’s dealers dating back to 2016.
Lookers’ decision to not set aside a provision means that, for the time being, management does not anticipate a fine from the FCA, according to Liberum. But investors took little comfort from this, and the disclosure was only the first of a series of dire announcements. On 5 July, Lookers’ chief financial officer, Robin Gregson, said he would step down after 10 years. Just a week later, the company issued a profit warning. The result? Since the bad news started rolling in on 25 June, the share price has dropped 37.5% to 42.5p on 12 July.
Amount Lookers' share price dropped from 25th June to 12th July
While other UK-listed dealership groups haven’t fared as badly as Pendragon and Lookers, ones that have taken a beating over the past few years are Vertu [VTU] and Inchcape [INCH]. Their share prices have lost 50% and 20% of their market capitalisations, respectively, since January 2016. Both have underperformed the FTSE 100 in the year to date, rising 8% compared with 11% for the UK’s leading share index. Inchcape’s trailing 12-month PE ratio remains a relatively healthy 18 compared with Vertu’s 7.6, Pendragon’s 7.1 and Lookers’ abysmal 3.4.
|1yr target est||24.00||133.83|
|Quarterly Revenue Growth (YoY)||-16.00%||2.90%|
Pendragon and Lookers share price vitals, Yahoo Finance, 16 July 2019
How should investors respond to recent developments in the car retailer market? One way could be to shift away from traditional franchised dealerships to alternative retail outlets for used cars. Despite thinning margins, used car sales volumes in 2018 stayed strong – even occasionally rising year on year – with some analysts suggesting the sector may get a boost if an economic downturn pushes buyers away from expensive new cars. Motorpoint’s [MOTR] shares have risen by around 30% since late April and are up 11% year to date. Auto Trader [AUTO], which has been capitalising on a shift to online buying and financing, is up 23% for the year.