Supercharged returns

PORTFOLIO POINT: Investors in Australian listed automotive stocks have been enjoying gains of more than 50% in some cases so far this year, and there’s plenty left in the tank.

Retail in Australia, on the whole, is growing anaemically at best. Yet there is at least one area performing very strongly – new car sales.

Just under 99,000 new motor vehicles were sold in Australia in September, a 4.7% seasonally adjusted increase, and the rising numbers across almost every state and territory backed up some improvement in recent consumer sentiment surveys. For investors, that’s good news and good returns for almost every related business – except the local car manufacturers.

Thanks largely to the strength of the Australian dollar, dealer discounting, and cheap, easily-accessible credit, sales hit a record high. CommSec’s recent car affordability measure showed it takes 27.5 weeks of average wages to buy a Ford Falcon, the shortest amount of time since 1977.

Industry figures have predicted the total sales for 2012 will beat the previous all-time record of 1.05 million in 2007. The overall recovery since the GFC is strong – and stands in contrast to broader retail sales, or the stock market (see graph below).

Click to enlarge

The investment story is counterintuitive considering the three car companies that manufacture here – GM Holden, Ford and Toyota – aren’t selling more cars. Those companies have cut jobs in Australia, and their struggles adapting to changing consumer desires are well documented.

KPMG’s national automotive practice leader, Carl Dilena, says it’s important to understand the mix of sales between local and imported vehicles.

“Volumes of locally manufactured vehicles have been in decline for decades,” he says. “Given the low volumes and the decline in export opportunities in recent times, local vehicle production is only viable with government support.”

That means direct-input parts suppliers in turn face a diminishing manufacturing environment. In Victoria, where the three car manufacturers are based, this year has seen the closure of parts makers APV Automotive Components in April and CMI Industrial in July, as well as scrapped plans for a new Nexteer factory.

Yet Australians are buying cars in record numbers, and for investors with the right perspective that has led to a silver – even a golden – lining.

The local secondary automotive industry has had a stellar year in 2012. You won’t find the good news in the traditional automotive segment, because many Australian companies that are directly exposed to our appetite for cars and driving are not traditionally lumped together and do not fit into one market category. Second-hand caryard owners such as AP Eagers, after-market parts makers like ARB, and online marketplaces like Carsales.com are all very different businesses. Yet all are dependent on cars, and all have strongly out-performed the market this year. Share prices have not only largely recovered from plunges in the GFC, but are surging toward new highs.

A quick look at the performance of some of these companies, and their outlooks, shows a very different picture for investors than the better-known automotive manufacturing sector – one much more in concert with the recent data.

Data via Google Finance

Selling the cars (APE, AHE, CRZ)

In addition to buying new cars, Australians are buying second hand cars and selling them as well.

Automotive Holdings is a vehicle retailer and logistics group, with more than 130 dealerships across Australia and New Zealand. AP Eagers sells new and used cars, trucks, parts and automotive services through franchised and non-franchised dealerships, and took a 16.3% stake in Automotive Holdings in July. Carsales.com is a classified advertising platform with directories for a wide range of vehicles. All are performing strongly.

Automotive Holdings has been one of the strongest market performers of the lot, and as the largest automotive retailer by sales, market cap and employee numbers it’s not hard to see why it has benefited from the strong car market.

At a recent presentation the company said volume was up across the industry, and consumer demand had remained strong in the first quarter of fiscal 2013. “Manufacturer finance offerings continue to attract interest,” the company said, and “car affordability [is] at its best level in decades”.

Carsales.com has also grown to become Australia’s dominant leading force in how people look for cars. Approximately 75% of time spent browsing online for cars currently occurs on one of the company’s sites, and the latest Roy Morgan research shows that browsing online is far and away the leading method of searching. Together, that means almost 40% of people looking for a car are doing it with Carsales.

As you can see below, the rise of the internet as a tool for buying cars, at the expense of newspapers, has been rapid and stark.

Media most useful in purchasing a new car

Click to enlarge

Source: Roy Morgan

Carsales net profit lifted 23% in the year to June 30, a special extra 6c dividend was paid, and EBITDA margins held at 55%.

In the company’s annual report, chairman Wal Pisciotta said enquiries to the online market’s new cars business were up 23% in the year, and: “It is pleasing to see inventory levels returning to normality and stock flowing back into dealerships, after going through the natural disasters in Thailand and Japan last year.”

“Both events had a significant impact on the production and distribution of cars into Australia.”

Carsales is currently attempting to buy the Trading Post business from Telstra (TLS), which provides online vehicle classifieds competition – as well as some other areas such as pets and DIY. If successful, this would further boost the presence of the business, however a statement from the ACCC last week said “a number of competition issues” had arisen from its review of the proposal.

A UBS analyst covering the stock said it was too early to say whether the concerns raised would block the deal or not.

Selling the parts (ARP, IFM, SUL, AMA)

Less directly linked to the surge in new car sales, but no less successful this year, are businesses engaged in supplying and even retailing after-market parts. While suppliers to the local manufacturers have been hit because sales of those cars is dropping, accessories such as bull or tow bars, aftercare, repair parts, servicing and added discretionary items such as sound systems are still in high demand.

Super Retail, which owns the Supercheap Auto brands of accessory retailers, just reported a 6% rise in like-for-like sales growth in the past 16 weeks for the auto division and expects to add eight auto stores in the year. Its growth and margins aren’t amazing, but in an otherwise weak and struggling retail market Super stands out.

On the wholesale side, AMA wholesales vehicle aftercare and accessories, and sells parts, bull bars, and operates brakes and transmission servicing workshops. Listed in 2006, the small-cap has managed to reduce more than $50 million debt in February 2009 to less than $20 million today. Projections have it under $10 million by June 2014.

Growth this year at AMA has largely been from accessory distribution. This has continued to be a driver, with vehicle accessory distribution revenue rising more than 35% in the first quarter of FY13, and total revenue up almost 17% compared with the comparable quarter last year.

ARB Corporation and Infomedia would be familiar by now to Eureka readers, as Roger Montgomery has written in some depth on each of these companies this year (see here, and here).

These are well-managed companies that have found profitable niches in the automotive market – Four-wheel drive accessories and modifications for ARB, and publishing parts catalogues and price quoting software for Infomedia.

ARB opened four new stores this year, and has more than 100 independent stockists. Executive chairman Roger Brown told the company’s recent AGM that research and development expenditure had increased, and that “the 2011/12 year was a year in which a significant number of new vehicle released occurred, providing new product opportunities for ARB.”

The company also reported 6% sales growth, 2% profit growth, and 9% dividend growth in spite of the apparently challenging wider retail malaise.

The way forward

The obvious question for investors is whether the good times can keep going.

While interest rates remain low, facilitating cheap financing, and the Australian dollar remains high, it is hard to see that Australia’s appetite for cars will diminish.

Many of the above companies have already reported strong sales in the first quarter of this fiscal year, and continuing growth in demand.

The expansive geography of Australia, coupled with often limited public transport systems in major cities, means cars are still expected to be the dominant mode of transport going forward. NSW government statistics found that over a 20 year period Sydney’s population grew 21%, but car trips increased 41% and the number of cars grew 58%.

New car makers are entering the market, China’s automotive manufacturing is emerging, and Australia has more brands of new cars available than the US. Adding to this is the growing movement towards the electric car, and the related technology and infrastructure growth that goes with that.

Finally, perhaps the most important area looking ahead for the industry and its related businesses is offshore. Dilena says “new export opportunities are essential for the future viability of the auto manufacturing industry in Australia”, and this holds true for the ongoing growth of many of the companies discussed above as well.

ARB grew export sales 6% in fiscal 2012, and said Thailand was becoming a “useful contributor”, but that the strength of the dollar was a major impediment to export growth.

Recently-listed iCar Asia (ICQ) is an up-and-coming Australian company that owns automotive websites in Indonesia, Malaysia and Thailand – seeking the same kind of success Carsales has had in Australia from the less mature regional markets.

Looking ahead, the dollar looks to be a two-edged sword for the industry. A lower dollar would increase export opportunities for local manufacturers, open up new markets and help to maintain the strong growth seen this year. However that same purchasing power is driving affordability here, and contributing to a car market fully recovered from the global financial crisis and now posting record sales.

Some Australian automotive businesses may bemoan the currency – but given the success seen above in a string of secondary companies which the high dollar has made possible through surging new car sales perhaps they, and investors, should see the opportunities instead.