Its shares trade at an unjustified discount to other internet-based businesses
Thursday 17 May 2018 Author: Tom Sieber

Weak sentiment towards the car market should not obscure the strength of vehicle listings website Auto Trader (AUTO).

Enjoying the low costs of being a purely internet-based business and the pricing power associated with its status as the runaway leader in the UK market, we think investors should take advantage of recent share price weakness before the market reappraises the investment case.

A near-term catalyst is on the horizon in the form of a 7 June results announcement for the 12 months to 31 March 2018. Alongside the numbers themselves, guidance is likely to be given for the 2019 financial year.

VALUATION ANOMALY

The recent takeover offer for Zoopla-owner ZPG (ZPG) shines a light on the valuation disparity between Auto Trader and other online businesses.

ZPG’s deal was struck at an EV/EBITDA (enterprise value to earnings before interest, tax, depreciation and amortisation) multiple of just over 20-times based on Berenberg’s forecast EBITDA for the September 2018 financial year.

This is not out of step with valuations for internet-based businesses in the US. It is also roughly in line with the consensus 2018 EV/EBITDA multiple for Zoopla’s main rival and UK property site market leader Rightmove (RMV) at around 23-times. By contrast Auto Trader currently trades on an EV/EBITDA of 15.85-times.

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WHY ARE THE SHARES WEAK?

The company revealed in March that used car stock for the current financial year could be flat or even down. Auto Trader is reliant on the used car market (around 85% of the stock on its website). This therefore spooked the investment community and prompted weakness in the share price.

There are two points to consider here. First the company has other levers it can pull to grow average revenue per retailer (ARPR). Second it is worth noting the aforementioned higher rated property portals serve a housing market which also has slightly uneven and uncertain prospects.

Property market volatility has not stopped Rightmove’s shares trading at record levels and, like Rightmove, Auto Trader benefits from a market share upwards of 70%.

Auto Trader’s website is the one most visited by prospective car buyers because it has the most listings. Car retailers are therefore compelled to use its products, reinforcing its position.

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WHAT DOES THE COMPANY DO?

Auto Trader’s main area of business is Trade Services which sells subscriptions to retailers on a contracted basis. The remainder is largely accounted by private sellers, advertising agreements with partners in areas like insurance, car finance and vehicle checking, and standard display ads on the site.

There are four key areas of operation – selling, buying, marketing and managing – and each one is broken up into different levels with price points moving progressively higher.

DIDN’T IT USED TO BE A PRINT MAG?

Launched in 1977 the print product was discontinued in 2013 leaving the company 100% digital. More than 70% of visits to its sites now come through smartphones and tablets. The company joined the stock market in March 2015 at a price of 235p per share.

Numis analyst Paul Richards notes that organic revenue has advanced at a compound annual growth rate of 9% since IPO (initial public offering) and says this growth has been delivered in equal measure by increases in underlying price, more stock carried on the site and new product development.

In other words, by cross-selling and upselling to existing clients, the company can increase ARPR and further bolster its returns even if the level of stock remains flat.

In the longer term the business sees opportunities to increase its penetration in the new car market and to enable transactions to be carried out online.

KEY POINTS TO WATCH

Numis’ Richards says in several ways Auto Trader will address the opportunities. ‘First, it will seek to maintain its leadership with used (and increasingly) new car buyers.

‘Second, from this position it will seek to move as much of the car buying process online as is practicable. Finally, the group will continue to develop products, data and services that deliver a higher return on investment to retailers than the offline products currently available.’

Like many companies which move from private equity ownership to the public markets, the company came to the market with a lot of debt. Fortunately strong cash generation has enabled the company to reduce its net debt to earnings ratio from 3.4-times to 1.6-times while still paying out a third of its earnings in dividends.

A potential risk is competition from other online platforms like Gumtree and Ebay but these more generic sites lack the brand awareness and capabilities Auto Trader enjoys in the car market. (TS)

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