The headwinds facing Autosports Group
Montgomery Investment Management
To understand the challenges facing the automotive sales industry, it is often helpful to examine a particular company, as Roger Montgomery did earlier this month.
Autosports Group (ASX:ASG) operates car sales outlets in Sydney, Melbourne, Brisbane and the Gold Coast. Its share price has been on a rollercoaster ride since floating in 2016 and currently sits below the $2.40 listing price. ASG is profitable and reasonably priced, but investors should be mindful of the threats facing its business model.
Established in 2006, Autosports Group owns and operates 40 retail businesses, including 23 luxury and prestige motor vehicle dealerships, two used wholesale motor vehicle dealerships and two specialised collision repair facilities in Sydney, Brisbane, the Gold Coast and Melbourne. Autosports Group represents Original Equipment Manufacturer (OEM) brands including Alpina, Aston Martin, Audi, Bentley, BMW, Jaguar, Lamborghini, Land Rover, Maserati, McLaren Mercedes Benz, Mini, Rolls-Royce, Volkswagen and Volvo. ASG offers new and used vehicles, finance and insurance, and back-end parts and servicing, including collision repair.
Currently, car dealers are operating amid a veritable storm. Deliveries of new vehicles are hampered by a semiconductor chip shortage and the shuttering of manufacturing facilities due to COVID-19 associated isolation requirements. Booming demand for vehicles however is undiminished, thanks to consumers unable to travel, and flush with cash (e.g., a booming construction sector lining the pockets of builders and tradies). The eroded appeal of public transport is also driving demand for private transport.
Unable to purchase a new car, buyers have turned to the used market where prices for many used vehicles have risen beyond their original purchase price of several years ago.
The agency threat
Meanwhile, in the background, the ever-present threat of OEMs moving to an Agency Model (Mercedes AG have already announced the change and are in court with dealers fighting for $650 million compensation) poses a revenue hazard to dealership revenues, putting investors on edge.
Under the current dealership model, a brand retailer buys a vehicle from the OEM as inventory at a wholesale price. Typically the vehicle is only paid for by the dealer when it is sold. A margin for the dealer to cover costs is added and the salesperson then negotiates a transaction price with a customer.
OEMs including Mercedes and Honda have expressed frustration with the traditional dealership/OEM relationship because dealer promotions including special offers, run-out deals, discounts and end-of-the-month sales all lower resale values and accelerates depreciation rates.
But it hasn't all been the dealers' fault. Dealers note they have had to pay for manufacturer 'mistakes', overproduction on their floor plan charges, incorrect build combinations and obsolescence. This is the reason for the "race to the bottom" on new-vehicle margins.
Under the Agency Model, dealers are paid a fee for a vehicle sale. For Honda dealers in NZ, this ranges from four per cent to seven per cent depending on meeting sales targets and customer satisfaction scores. Elsewhere, the customer places their order directly with the OEM and nominates a preferred delivery dealer. The price and dealership mark-up or commission is set by the OEM.
The positive spin put on the agency model by OEMs says dealers aren't limited to selling just the cars allocated to them. They are free to sell any vehicle model in the brand's stable on order nationally. Dealers have access with access to the full range without incurring floorplan costs.
The OEM owns all demonstration stock at the dealerships and all the new-car stock. New vehicles are held for sale at a national distribution centre and sales are made directly to the customer. The dealer therefore no longer finances an inventory of vehicles for sale, and all floorplan or finance costs are borne by the OEM. In Volkswagen's electric vehicle agency model in Europe, the dealer is offered a lease program for demos and loan vehicles.
Across the globe, the use of agency models is more widespread.
Mercedes-Benz has already introduced agency models in South Africa, Austria, Sweden and it will transition to one in Germany as well. Volkswagen is rolling it out for selling electric vehicles in Europe and Honda has been running the model in NZ since 2000.
Back to ASG
Navigating this tumult is a challenge attested to by a 30 per cent decline in ASG's share price since its high of $2.74 last June.
Autosports Group reported its first half FY22 results recently noting the solid margins of the previous financial year continued, driving profit before tax to beat some estimates by more than 10 per cent.
The company however reported revenue of A$911 million, which grew 0.8 per cent year-on-year (yoy) but missed consensus estimates for $1 billion. Revenue was down four per cent when adjusted for acquisitions, which contributed $44 million.
EBITDA grew 27 per cent yoy to $48.6 million, beating some estimates by 10 per cent. Adjusted profit before tax of $39.2 million was up 35 per cent on the previous corresponding period and beat consensus estimates for $33.8 million by 16 per cent.
Revenue for the sale of new vehicles was unchanged on the same period a year ago at $564 million, thanks to an inability to obtain sufficient stock. A combination of strong demand, and that inability to deliver new cars, has also resulted in the company's new vehicle order book doubling from a year ago. New orders written in the first half exceeded deliveries by 22 per cent.
Over in the used car department, vehicle revenue of $209 million was also flat yoy but strong growth in the final quarter of the calendar year was implied by the fact the first quarter was down 12 per cent yoy due to lockdowns.
The services department generated $59 million in revenue, which was nine per cent higher than the previous corresponding period and parts generated $60 million of revenue up 13 per cent yoy.
The growth in profit, which exceeded revenue growth, was the result of higher selling prices (on less stock) and therefore improved margins. Gross margins of 19.2 per cent was an improvement on the 17.8 per cent generated in in the second half of FY21.
The company's outlook remains clouded by a comprehensive lack of clarity about when deliveries will return to normal. Supply constraints are expected to last the remainder of the calendar year at least. Demand should therefore continue to exceed supply. The Used vehicle, Service and Parts divisions are expected to generate revenue growth of between six and ten per cent. Longer term the business model remains under the cloud of threats from OEMs moving to an agency selling model.
Author: Roger Montgomery, Chairman and Chief Investment Officer
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