Bought some Vertu last week average price of 59 – small portfolio weight 3%.

Its much more GARP related than my usual investments.

Business model is – buy little car dealerships at a low multiple combine them to create a bigger group valued at a far higher multiple.

I usually don’t like acquisitive companies but this seems like an innately good idea.

Lets go through a few deals to see how they work – firstly Vertu issues shares to buy these dealerships – via a placing to city big boys.  I don’t much like this I would rather have a rights issue – as it’s more equitable and I can take part – but the placings have all been done at fair prices.

I will look through a few of the recent deals done

Last RNS (June 2016) they bought Gordon Lamb for £18.7m – value of net tangible assets of £10.2m.  Much of this is freehold land and new/used cars – all readily sellable.  So they are paying £8.5m for PBT of £2.7m – a 3X PBT multiple vs non tangible assets or 7X tangible assets.

They paid £21.9m for Greenoaks – Net assets of £6.2m and PBT of £1.2m but revenue of £88m – so obviously something is going wrong here – PBT is too low.  Greenoaks also has 4 sites which are freehold.

They paid £2m for 3 lookers Honda dealerships trading at break even.  It has been sugested that this sale was forced by the manufacturer.

In October 2015 they paid £12.8m for SHG – a Hereford based dealer with net assets of £4.3m.  Earning PBT of £1.5m – so a 8.5X multiple or 5.6 excluding tangible assets.

Vertu as a whole is trading at 8.6X PBT (Sharescope figures Feb 2016).

They aim to run the dealerships more efficiently – consolidate in regions and make more money.  I would imagine a bigger operation would also get better prices from manufacturers also.  Good article on them operationally is here.  Not sure how much difference a focus on data makes vs other big players but will aid smaller ones.  I like the approach being more open to part time working etc….

This seems to be going well – since 2011 Vertu has raised pre tax profit from £5.25m to £25m.  EPS has risen from 2.4p to 5.99p – PE of 9 at current prices.

The group trades at a MCAP of £223.5m but has tangible assets of £127m including 23m in cash (from 2016 annual report) – though some has now been spent on acquisitions.

The UK is highly fragmented in terms of car retail – Pendragon, the largest is only 8.5% of total industry revenue – according to this link – so lots of opportunity to consolidate or be acquired at this multiple.

They are looking at raising debt to do more acquisitions…

I have had a look at multiples for Lookers / Pendragon and they are on a comparable PE to Vertu but have debt. Lookers has grown EPS a comparable amount to Vertu but has used debt to do it. Pendragon hasnt grown at all.  I think Vertu should trade at a premium to the rest of the sector.

Inchscape is more expensive but is far bigger and a global player.  Cambria is much more expensive but has grown more slowly !  It does have a stronger asset backing.

I am often hesitant to buy a low PE fast growing stock as it can indicate the top of the market.  There is much talk of a bubble in UK car retail.

I dont see it.

I have had a look at the ONS and I think the key links are:

Total Licensed vehicleshttps://www.gov.uk/government/uploads/system/uploads/attachment_data/file/515957/veh0101.xlsx

Total First Time Registrations: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/521840/veh0150.xlsx

There are lots of way to cut this.

Total 2015 car registrations were 2.6m.  This is 36% higher than the low of 1.9m in 2011.  It still is not obvious we are in a bubble – from 2001 to 2007 car sales (I am using registrations as a proxy) were at or over 2.4m every year.  The number of cars on the road has increased by about 10% since then so sales of 2.6m look sustainable.

If we are pessimistic and assume we are in a car sales bubble – a fall of 36% of sales to the 2010 and 2011 levels actually won’t impact profitability too much for Inchscape.  New car sales are 76.9m / 263.3m of total gross margin.  A fall of 40% in new car sales implies a fall of 12% in total gross margin.  Net margin may fall more, particularly initially but there will be costs which can be cut offsetting this.  Wages and salaries are a big (63%) proportion of total expenses.  This is very much a worst case scenario, its very hard to put a figure on it….

Its also likely that if there was a fall in new sales there would be a fall in sales of used cars and after sales – both very profitable areas.  Hard to put a figure on it but this is not a share I want to hold in a recession.

There has also been some Brexit speculation – if we leave and if the GBP falls it might be less profitable to sell in the UK.  I’m somewhat sceptical of this.

It seems likely there may be a positive earnings surprise – registrations are on a high in March and the results to reflect this will come out in mid July if past years are anything to go by – will hopefully be a positive catalyst.

I work free Cash flow at about £21m – ex working capital movement.  Given the balance sheet strength there is an opportunity for re-rating…

Target at which I will get out at is probably about 80-90 – with a bit of luck 12-14x 2018 earnings…

This shouldn’t be too hard to get to – we were almost there in December 2015.  My confidence level isn’t as high as usual on this one, not sure why bit uncomfortable about possibility of a slowdown / Brexit hitting the stock.  I think the worst case is in the stock so will try to steel my nerves.

 

EDIT 04/07/2016

Sold out of this at 50 – loss of 16% on Brexit day.  Now 41p – shows benefit of reacting to bad news.  This isnt a stock I want to hold in a recession which I think is coming… Equally ER movements make it a difficult business to be in.

 

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