Automotive Dealers Brace For Soft Sales

This story features EAGERS AUTOMOTIVE LIMITED. For more info SHARE ANALYSIS: APE

The latest industry data suggests market conditions are particularly challenging for the automotive dealerships and this offsets the passing of the financing headwinds that have plagued the sector recently.

-Severe decline in new car sales in four months to April, particularly in Queensland
-Lower volumes leading to increase discounting and result in reduced margins
-Increasingly high acquisition multiples are reducing the opportunity for accretive transactions
 

By Eva Brocklehurst

The latest industry data suggests market conditions are particularly challenging for the automotive dealerships and this offsets the passing of the financing headwinds that have plagued the sector recently.

Moelis understands that enforcement of responsible lending obligations are partly to blame for softer trading, as some high risk customers can no longer obtain vehicle finance and have left the market. Lower volumes have led to increased discounting, as dealer groups chase market share, and this results in weaker margins across the industry.

The broker believes manufacturer's volume incentive targets are not aligned to the current market conditions. Given continued weakness in market conditions Moelis expects targets will be re-aligned at some point in the second half of the year, and when this happens a small amount of margin improvement is expected.

Furthermore, the broker understands, with private equity players continuing to look for acquisitions, acquisition multiples are expensive and large-scale dealership acquisitions are unlikely in the next 12 months as both AP Eagers ((APE)) and Automotive Holdings ((AHG)) remain disciplined in their approach.

Morgan Stanley believes the outlook for new car sales is challenged, as is the case with consumer confidence. As well, mortgage rates are also now moving higher after a prolonged period of reductions and finance availability has tightened, with increased scrutiny and enforcement of lending rules by ASIC.

The broker believes these conditions will keep the pressure up on dealerships. Margins have also peaked and thus the broker lowers the margin outlook, driven by lower rebates and lower flex commissions. The broker's forecasts assume that the market normalises as manufacturers re-set targets but there is still a risk of negative momentum.

AP Eagers

AP Eagers has signalled a weaker than expected outlook for the first half of 2017. Trading conditions are particularly subdued in Queensland, exacerbated by lower manufacturer bonuses. The company expects pre-tax profit to decline by -7-9% in the first half.

Ord Minnett observes, while the financing headwind is reducing, and there are cost saving opportunities, these are more than offset by weak car sales data. The broker believes automotive retailing is challenged, given industry sales data and increasingly high acquisition multiples which reduce the opportunity for accretive transactions.

Market conditions appear particularly challenging in Queensland where vehicle sales were down -5.9% in January to April, and down -2.8% nationwide. June is typically the largest sales month and there is some opportunity for recovery but brokers observe the trend is clearly weak and the operating environment for the automotive dealerships is fragile.

Ord Minnett notes that the financing headwinds from the changes to flex commissions have largely abated, while AP Eagers did flag finance margins in the first half to date are largely in line with the second half.

After a severe de-rating in the share price for both AP Eagers and Automotive Holdings, Morgans has become more positive on both stocks. Nevertheless, the broker elects to maintain a Hold rating and would prefer to confirm a stabilising, or improvement, in new vehicle sales for May and June before upgrading.

Moelis observes guidance implies volumes have not picked up in May and, along with June, this is the most important trading period of the year. The broker does not expect any benefits from cost reductions until at least the second half.

Moelis, not one of the eight stockbrokers monitored daily on the FNArena database, downgrades forecasts for earnings per share by around -7-8% over FY17-19 to reflect lower organic growth at lower margins, as manufacturer incentives catch up to a weaker market. Target price is $8.28 and a Buy rating is retained.

Morgan Stanley prefers AP Eagers over Automotive Holdings because of a focus on automotive dealerships without the logistics drag. Nevertheless, the negative outlook and risks to the downside means the broker downgrades to Underweight, and reaffirms an Underweight rating for Automotive Holdings.

Automotive Holdings

Moelis believes the market situation is similar for Automotive Holdings but expects cost reductions can offset some of the margin pressure in the company's key geography of Western Australia.

The company has downgraded guidance to underlying net profit of $87-89m for FY17. Moelis reduces forecasts for earnings per share by -4-9% over FY17-19. Buy rating is retained and the target is lowered to $4.11. While the company's restructuring and business closures will result in a non-cash one-off cost of -$35m, the broker considers this a clear positive as it provides a stable base for growth going forward.

UBS downgrades the stock to Neutral from Buy on the back of the downgraded guidance. The broker suspects that, given an apparent plateauing of house prices and the subsequent wealth effect, there is a risk the weaker household cash flow will impact on new car sales in FY18.

Morgans expects that Automotive Holdings will still experience some heat from the severe decline in car sales in Queensland, although Western Australia remains worse from a volume perspective. The company's cost reduction plans may well provide a buffer from continued softening but the broker prefers to await more positive signals from the industry.

The company has confirmed a delay in the cost reductions in cold logistics and, while Morgans hopes that a material improvement in this business will assist divestment, the delay is considered a further negative. Divestment may not be necessarily accretive to earnings but would allow Automotive Holdings to capitalise on more automotive acquisitions and potentially pursue capital management.

Has the worst of trading conditions passed? Morgans assesses it is too early to make this call and awaits further evidence in the form of upcoming industry data.

The database shows three Hold ratings and one Sell (Morgan Stanley) for AP Eagers. The consensus target is $8.32, suggesting 9.3% upside to the last share price the dividend yield on FY17 and FY18 in forecasts is 4.6% and 4.8% respectively.

There are four Buy ratings, two Hold and one Sell (Morgan Stanley) for Automotive Holdings on the database. The consensus target is $3.81, suggesting 25.4% upside to the last share price. The dividend yield on FY17 and FY18 forecasts is 7.2% and 7.6% respectively.

See also, Car Dealer Issue Is Soft Growth, Not ASIC on March 6 2017.
 

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