UK Auto Dealerships
head to head!
By Manuel Maurício
May 21, 2021
I’ve recently looked at Cambria Automobiles after news came out that the management was offering to take the company private at £0.8 per share, but I was left with the feeling that I should learn more about the business.
This week I’m taking a closer look into the intricacies of the 4 most relevant auto-dealerships in the UK: Cambria, Vertu, Lookers, and Pendragon.
Before getting into the weeds, a bit of macro is important. We must understand that we’re looking at a cyclical business.
Aaaand, it seems that we’re at the bottom of the cycle? For various reasons, the new car market in the UK has been decreasing since its peak in 2016.
The image above was taken from Pendragon’s most recent presentation. It’s pretty funny that on the last year’s presentation they were expecting the volumes for the next couple of years to stay flat, but the pandemic seems to have changed that.
I see 2 reasons for the upgraded guidance: People have more cash in their pockets because they didn’t spend it through the pandemic (on holidays for example), and the “fear” of public transportation (I think this is an overreaction, but to each their own).
By looking at the chart above, it seems like we’re on the lower part of a new cycle. There is high demand for cars right now, which, together with the global shortage of semiconductors, has led to a big rise in prices of used cars.
Ok, so now let’s start looking at the companies.
The fist thing I’ll want to be doing is comparing the relative size of each one. First by looking at the total enterprise value (market capitalization + debt – cash)…
And then by looking at the revenue.
Clearly Cambria stands out as the smallest of them all. I like this for the simple fact that there are no relevant advantages of scale in this business and and also because the UK market is highly fragmented, which means that there is still a lot of room for a small company to grow.
The next thing I’ll want to be looking at is the revenue composition for each of them.
Fairly similar at first sight. It’s interesting how all of these companies had different revenue compositions 10 years ago and how they’ve all converged to looking very similar. I like to see that Cambria has the highest proportion of both Used Vehicles and Aftersales as these are the two most defensive segments.
Then I’ll want to be looking at the gross margins.
Cambria stands out as the company with the highest gross margin. Notice that we’re talking about minuscule differences, but that’s the way it is. The auto-dealership business has very low margins.
Side note: For those who want to track my math, throughout this write-up I’m using the average for the 3 years prior to the pandemic to smooth out any one-time variation and not account for the effects of COVID-19.
Cambria first started out with a strategy of acquiring under-performing dealerships, applying best practices, and turning them around. It was very successful with that strategy, but in 2013 the board and managers decided to shift focus to the high end of the market, going from volume to luxury.
My first thought was, higher gross margins! But I quickly realized that that hasn’t been the case.
I was intrigued by this so I decided to collect segment information as far back as I could. By looking at the chart below, it becomes clear that the margins on both the new and used car sales are as steady as they come: 7% for the used cars and 9% for the new cars.
I wanted to check if the other companies had similar margins on a segment basis.
In the New Vehicles segment, Cambria has the higher margin. In the Used Vehicles segment, it’s a tie between Cambria and Vertu, and in the Aftersales segment, Cambria comes last. There are some things we should bear in mind:
First, within the New Vehicles segment there are 2 sub-segments (private, and fleet + commercial) and the mix between these two will influence the margin as the “fleet + commercial” has much lower margins.
So the higher gross margin in the New Vehicles segment that Cambria is able to achieve comes from a mix favoring the Private Cars rather than Fleet + Commercial (good call).
Second, whereas the after-sales gross margin for Cambria, Vertu, and Lookers is calculated in relation to the revenue to outside customers plus inter-segment revenue, Pendragon only reports margins on the outside revenue, thus making their margins look higher.
I must confess that I still haven’t figured out what the inter-segment revenue is in the auto-dealership business. If anyone reading this has any clue, I’d be delighted to hear.
Another intriguing detail is the fact that Cambria has lower gross margin compared to all the other peers in the After-sales segment (the best segment). I’ve asked around to other investors why this happens and this was the best answer so far:
“maybe CAMB Aftersales are more weighted towards parts sales. Parts margins are far lower than Service, so the more weighted towards parts sales, the lower the overall Aftersales margin.”
That seems to make sense, but why would Cambria be any different from the others?
Anyhow, I would love to see Cambria getting to those 44% gross margins of its competitors, but I’m not counting on it as it has never happened before.
Ok, so now I understand that the mix of Private Cars vs Fleet + Commercial plays a big role in the gross margin, but I have yet to understand why the gross margin hasn’t gone up as the company shifts from the volume to the luxury segment.
My best guess is that the car manufacturers hold that decision in their hands. They know for how much the cars sell to the public so they’ll sell them to the dealerships at a price that will give exactly the same margin in percentage terms. This is actually quite good.
Having a 7% margin on a Ford Focus will be different from a 7% margin on a Ferrari. The dealer will earn more money by selling the Ferrari (as long as it turns the inventory, at least, the same amount of times. I’ll be talking about this on Part 2).
So if the margins don’t show us the shift from volume to luxury, I thought that looking at the gross profit per new car would do the trick.
And it did.
In the chart above, we can clearly see the rise in profit per new car from the moment that the company decided to shift to the luxury segment back in 2013/2014.
What about the other companies? Do they get the same profit per new car as Cambria? No they don’t. They don’t even get close.
Truth be told, this could just be happening because of the mix between the two sub-segments. I should be looking at the gross profit per new private car –not just per new car – as this is the largest sub-segment for Cambria.
Unfortunately only Vertu discloses sufficient information. Vertu gets, on average, £1.586 per new car sold, still way lower than Cambria’s £2.743.
So, at least, in comparison to Vertu, Cambria sells more expensive cars and gets more money for each car sold. The choice to go after the luxury segment appears to have been paying off.
OPERATING COSTS
After looking at the gross margins, I’ll want to be looking at how well these dealers operate their businesses.
I’ll do that by looking at the expense ratio which is calculated by dividing the costs to run the operation by the revenue. The lower the better.
Here, the race is tight. I would expect Pendragon and Lookers to have the lowest ratio of all because their size should allow for the central costs to be diluted by a higher revenue, but I guess I was wrong. There really aren’t economies of scale in the auto-dealership industry.
As an anecdote illustrating how these guys keep the costs low, I’ve heard one investor say that Cambria doesn’t have headquarters. All the managers are mobile, meaning that if they need a desk, they will hop by a dealership and sit wherever they can. The monthly management meetings are held in hotels. And this isn’t because of the pandemic, this was already happening back in 2015!
So, to wrap up the margins subject, a higher gross margin together with a not-worst expense ratio leads to a higher operating margin. So far, Cambria wins.
We’ve reached the end of Part 1. Next week I’ll be looking at the efficiency ratios, the returns on capital, the balance sheet, the management and capital allocation, and finally, the valuation of each of these companies to see which one is the best.
I know that I’ve presented a lot of metrics that might be hard to grasp for novice investors, but that’s how these industry analyses work. If you have any doubts, please post them on the Facebook Group. I’ll be more than happy to help.
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