Carsales: Interim result 2017

If Carsales.com's managing director Greg Roebuck is stepping down before the problems hit, there was no sign of them in the 2017 first half result. Has all the worrying we've been doing lately been for nought?

In Carsales' core Online Advertising business, revenue growth was stronger than expected at 13%. Both dealer and private revenue marched upwards at a decent clip, with earnings before interest, tax, depreciation and amortisation (EBITDA) rising 9%. It was pleasing confirmation that the Carsales core business is indeed motoring (see our November upgrade).

Notwithstanding cyclical risks, the medium to long-term growth potential for the core business might be somewhat better than expected. The company has been introducing new products for dealers that should help accelerate vehicle turnover (car dealerships are a volume business, so turnover speed increases dealer profitability).

These products could lift Carsales' revenue growth significantly. Combine that with long-term cost growth that's likely to reduce from the first half's 12% and there's the potential for a step-up in profitability at some point.

Also pleasing was that Carsales lifted its standard private seller ad from $65 to $68 last month. It has also lifted the free ad threshold from $3,000 to $5,000. Both moves suggest the company is comfortable enough to attack main competitor Gumtree on its own turf (which has a significant share of low-value vehicle ads).

Stratton setback

What the market was most worried about, however, was the performance of finance business Stratton. While its difficulties – outlined in Carsales' Stratton splutters – meant that revenue fell 22% and EBITDA fell 49%, it could have been worse. Management indicated that Stratton was working on a turnaround, with growth expected to resume in 2018. It's too early to know if a writedown will be required, but management seemed confident this is more of a setback than anything worse.

While on the subject of writedowns, management wrote down the value of the stake in iCar Asia by $7m, as expected. The company reclassified the investment as ‘available for sale', which suggests it's a seller at some point.

What's particularly interesting is how quickly Carsales has pivoted from interest in Asia to expansion in South America. Last month Carsales acquired the Demotores online automotive classifieds business for the very reasonable price of $7m. Demotores owns websites in Chile – where Carsales' chileautos.cl is already number one – as well as Argentina and Colombia.

Along with Soloautos in Mexico and Webmotors in Brazil (in which Carsales owns a 30% stake), it now has five businesses in Central and South America. It's clearly trying to take on the ASX-listed Latam Autos (ASX: LAA) which, like iCar Asia, has struggled with how capital hungry early-stage ventures can be. Indeed, that's something Carsales will need to watch itself.

South Korea stunner

Brazil's economic woes took a toll on Webmotors in the first half, with EBITDA falling 24%. But at SKencar in South Korea, the company's largest and most advanced international business, earnings went the other way, rising 18%. While Carsales' 2014 acquisition of a 50% stake in SKencar looked expensive at the time, its performance has justified the company's confidence.

Adding it all up, the $7m iCar Asia writedown means Carsales reported net profit fell 8% to $47m. On an underlying basis, though, net profit rose 5% – not enough to get the blood pumping, but decent enough in the circumstances (see Table 1).

With the core business performing a little better than expected in the first half – and showing future promise – the stock jumped 8% yesterday. Partly the share price increase also reflected the market's relief that Stratton's woes look temporary, even though it's unlikely to return to peak earnings any time soon.

Management said the second half had started well and, as January and June are seasonally strong car-buying months, there will be the usual second-half bias. So underlying earnings per share of 47–48 cents looks achievable in 2017.

More important than any one year, though, is the longer-term growth profile. Early signs are that the core business might not be as mature as thought, although we still expect there to be some cyclicality. Also reassuring is that Stratton looks likely to recover in 2018.

Good things tend to happen to great businesses, although we prefer to buy on bad news, which is exactly what we did a few months back in Carsales' core business motoring. We're a little more reassured after this result, and very happy to HOLD.

Note: The Intelligent Investor Growth and Equity Income portfolios own shares in Carsales. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.