Carsales: Result 2018

It's a crying shame Carsales owns just 30% of its Brazilian associate Webmotors. The division has been the star of 2018, with underlying earnings rising 81%. So much for a tough economy; while Seek's Brazilian business took a tumble in 2018, Carsales' couldn't have been more different.

There's a downside to Webmotors' wonderful performance of course. If Carsales ever wants to buy the remaining 70% of the business it will end up costing a bundle. The knowhow Carsales has provided to Webmotors could end up proving very expensive, particularly as 2019 is expected to be another year of ‘strong' earnings growth for the Brazilian business.

Carsales' other Latin American businesses – in Chile, Mexico and Argentina – were in aggregate loss-making in 2018. The Chilean division is the clear market leader but the other two are best regarded as lottery tickets and none of them are likely to contribute much to earnings for the foreseeable future.

SK Encar – Carsales' now 100% owned Korean business – performed better than we had expected at the half-year result. Despite disruption from the Pyeongchang Winter Olympics in the second half, full-year revenues and earnings rose 15% and 8% respectively.

Management believes there's a lot that can be done to improve SK Encar's performance now it is fully owned. However, there are always risks after taking control of a business that once had a local partner, particularly when you've paid a big price – as Carsales has.

Oi, oi, oi

For all the international excitement, however, Carsales' Australian business still generates 88% of earnings. And while the domestic division produced a very decent result, with revenue and earnings before interest, tax, depreciation and amortisation (EBITDA) both up 9%, the quality of the company's revenue growth is inferior to its online classifieds peers.

Take dealer revenue growth, for example. In 2018 dealer revenue rose 8% but much of that was due to an increase in the price per lead Carsales charges. The volume of leads grew by a ‘low single digit' percentage.

While Carsales says the demand for premium listings from dealers is growing strongly, there's probably less potential to grow this revenue than its online peers like Seek and REA Group (mainly due to the low margin nature of the car retailing). The price per lead revenue model could be an issue at some stage too – it's a metric Carsales wants to maximise but dealers prefer to minimise. The volume of leads is also likely to weaken during slumps in consumer demand for used vehicles.

Private revenue grew 21% and, while some of that is due to Carsales successfully shifting private sellers to premium listings, much of the growth is coming from the lower margin Tyresales. Also, Display revenue – which grew just 3% in 2018 – is a relatively high proportion of Carsales' total, at 16%. With Display revenue potentially at risk of drifting to other advertising channels like social media over time, it's a little high for comfort.

Credit tightening

Elsewhere, the Finance business grew revenue 24% but the division is still labouring under regulatory issues. The Financial Services Royal Commission has seen a tightening of credit, and ASIC's ban on flex commissions lands in November. Finance division EBITDA fell 3% in 2018.

Overall, Carsales revenue and EBITDA rose 19% and 16% respectively in 2018. Excluding the effect of the SK Encar acquisition, the relevant figures were 12% and 8%. Underlying net profit grew 10% to $131m.

This is the fastest profit growth Carsales has achieved since 2014 but acquisition and price-led growth are lower quality drivers. Interestingly, the market seems to be taking a similar view; Carsales' share price has underperformed its peers over the past year (although it's still up 13%, and 38% since our highest Buy recommendation).

At this stage we don't see a reason to lift our price guide given the issues highlighted. Our Buy price of $12.00 a share reflects a 2019 forecast price-earnings ratio of 20. While that would be a bargain for Seek or REA Group, we prefer a higher margin of safety for Carsales. Our recommendation remains HOLD.

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

Disclosure: The author owns shares in Seek.