- The business has consistently created shareholder value through share buybacks and dividends.
- Due to the COVID-19 panic in March 2020, the shares are trading way below past multiple averages.
Editor's note: Seeking Alpha is proud to welcome James Weston as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA PREMIUM. Click here to find out more »
Editor's note: This article was amended on 8/4/20 to reflect minor corrections in the referenced data.
I am bullish on Auto Trader (OTC:ATDRF) due to its high quality capital light business model led by a management team with a track record of rewarding shareholders. There is potential for more earnings growth in the future given a high chance that more users will subscribe to the business offering. Further, the market has mispriced the shares which trade at less than half a past 6 quarter average Price to Book ratio and I don't see any downside in fundamentals.
Taken from S&P Capital IQ database.
Auto Trader is the UK's largest digital automotive marketplace, with more time spent on its platform than any other automotive site by its audience.
Users of the platform are defined into 3 categories:
- Consumers: the general public who own cars, involved in transactions as both buyers and sellers.
- Trade: car dealerships in the manufacturer distribution network, as well as used car dealerships.
- Manufacturers: producers of cars (i.e. the car companies), they sell to fleet and lease companies and buyers in their franchise network.
Due to the diverse range of consumers, Auto Trader has acted as an intermediary for every party buying and selling cars by promoting them on its platform. Its cost per advertisement revenue model for consumers, and monthly subscription fees for the other car sellers and (recently) logistics companies, has allowed it to aggressively grow its top line since its IPO filing in March 2015. This has created substantial value for shareholders through dividends and share buybacks, allowed by a capital light cost structure.
Retailers made up 84% of revenues in FY 2020 S1 (fiscal year end in March). The company had an 85-90% franchise retail penetration and an 80-85% market penetration for independent retailers. After making a series of acquisitions to develop its online platform in 2010-2012 (vAuto, VinSolutions and Deltapoint Associates), Auto Trader has de-levered its balance sheet. The acquisitions have produced an offering that has led to significant and consistent returns on capital.
*Junior debt finance cost of £29.4m in FY 2015, as well as a particularly high interest expense of £92.9m.
**Paid down £147m in debt in FY 2016 without issuing stock.
Data from annual reports and charts were created by the author.
Network effects have allowed Auto Trader to grow successfully, as more customers are attracted to the platform by the variety of vehicles advertised and the ability to conduct very specific searches through a variety of criteria that other platforms, such as eBay (EBAY), don't have.
eBay entered the automotive marketplace after acquiring Motors.co.uk in February 2019, advertising vehicles through Gumtree UK. I feel that Auto Trader's business is superior as it allows for more refined searches in terms of financing and car tax specifications. Additionally, it also supplies a larger number of vehicles for consumers, as well as involvement with each rung of the supply chain of vehicles from manufacturers to consumers. The positive feedback loop generated by its network effect and data analytics will allow it to continue to compound earnings and offer a superior product. Gumtree/eBay has had little success, with audience share falling from 19% to 11% over the past 2 years. So, they're struggling to compete while Auto Trader has grown its users.
Average number of cars per month on Auto Trader (from annual reports)
FY 2020 S1
There is still potential for conversion of more users to the platform; management identify 120,000 new cars that aren't advertised to consumers by dealers. Auto Trader currently has approximately 30,000 brand new cars advertised by dealers, conversion will lead to higher revenues and cash flow as more people become attracted to the platform.
The superior business model is supported by the growing UK car parc, allowing more vehicles to be advertised.
Acquisitions and Joint Venture October 2019 - KeeResources Acquisition (£25.3 million)
This further improves Auto Trader's access to data, on top of its growing user base, to improve customer experiences. KeeResources offers a warehouse of vehicle taxonomy data (sourced from manufacturers) and software solutions for online user experiences, allowing it to strengthen its platform.
December 2018 - Cox Automotive Joint Venture (51% owned by Cox, 49% by Auto Trader)
The new Dealer Auction platform will provide a B2B platform that is data-driven to improve profitability for vendors and retailers in a single marketplace with easy access to additional services, such as logistics and wholesale funding provided by partners. Auto Trader aims to connect retailers with vehicles through this auction platform.
April 2017 - Motor Trade Delivery Ltd. Acquisition (undisclosed amount)
Acquiring Motor Trade Delivery was a great core acquisition in my opinion, as the company is a platform for logistics companies to source opportunities through them bidding in live auctions. This reduces hassle for clients such as dealerships and manufacturers who will save time by finding a logistics partner more quickly.
Management strategy and execution
In their latest annual report, management laid out their objectives:
1. "Maintain the best consumer experience for buying and selling vehicles."
2. "Create and maintain high-performing, data-orientated teams. Data is fundamental to decision making within the organization and we constantly strive to improve our capability in this area."
They have executed well here, through the KeeResources acquisition and the Cox JV, which improve access to secondary and primary data respectively. Given Auto Trader reported £89m in current assets as of September 2019, the £25.3m KeeResources acquisition was inexpensive and so hasn't impacted the company's solvency.
3. "Grow ARPR (Average Revenue per Retailer) in a balanced and sustainable way, by creating value for our customers."
The number of users that has grown through time demonstrates success here (ARPR is up 7% y-o-y in FY 2020 S1, price levers contributed 34% to the increase of 9% y-o-y for FY 2019), the other strategic objectives will fuel this growth as they emphasize increasing the quality of the Auto Trader platform. Given Auto Trader's high cash conversion of 98%, growing ARPR will reward shareholders.
4. "Improve stock choice, volumes, accuracy and transparency in both new and used vehicles."
With the growing number of users and use of Auto Trader throughout the vehicle supply chain, Auto Trader are executing well here.
5. "Develop a more efficient way for retailers to source, dispose and move vehicles. A consistent pain point for retailers is how they currently source vehicles outside of consumer part-exchanges."
The Motor Trade Delivery acquisition allows retailers to source logistics much more efficiently as it is an auction platform. So, retailers are given a choice of logistics providers in one place reducing the time finding a logistics partner.
6. "Our research suggests there is a growing desire to complete more aspects of the car buying journey online. We continue to look at the various component parts which might make up that transaction journey and how we might offer those on Auto Trader."
This shows a conscientious management team, searching for more growth verticals that could benefit profitability in the future.
Hidden assets to be added to Book Value
- The Cox Joint Venture was recognized as a transaction, Auto Trader have a 49% stake in the JV and paid £19.7m to Cox in FY 2019 for this stake, which is a hidden asset as it can produce earnings for Auto Trader.
- Marketing. Auto Trader spent £17.6m on marketing to "maintain and enhance our audience position and educate consumers on new products such as new car offerings and search by monthly payment." Given that marketing is used to "maintain" consumer engagement it can be capitalised as an asset in my opinion.
- Marketing spend is maintained at 5% of revenues per year. This leads to total hidden assets worth £38m for FY 2020 S1.
Reported total assets plus hidden assets (£m) FY 2020 S1
Total Reported Assets
Total Reported Assets + Hidden Assets
The average Price to Book Value for Auto Trader for the past 6 quarters is 120.1x, Auto Trader traded at 54.01x book value at the 29 the May 2020 close, due to the recent bear market.
Present Book Value including hidden assets can be calculated as follows:
Shareholder Equity (Book Value) = Reported Shareholder Equity + Hidden Assets
= £95.5m + £18.3m + £19.7m = £133.5m
Book Value per share = £133.5m ÷ 923.9m shares outstanding≈ 0.144
Assuming mean reversion to 120.1x P/BV
Share value = 0.144 x 120.1= £17.29 (priced at £5.51 as of 1 st June 2020 close)
Why I chose the mean reversion assumption
I chose the above method of valuation as unlike a DCF it does not rely on future earnings projections which are impacted by multiple independent variables and so carry a certain degree of uncertainty. This method relies on how the business has been priced given its current state, and the state hasn't deteriorated so in my opinion the shares are trading at a sale price.
The recessionary impact of COVID-19 is likely to have little impact on Auto Trader's revenues in my opinion, retailers will still want to sell their cars through the platform with substantial viewers and will continue to pay subscription fees. Auto Trader could be one of Buffet's toll bridges which he mentions in his biography The Snowball, where businesses, in this case car sellers, need to pay the subscription/ "toll" to stay competitive.
This is further supported by recent research conducted by Auto Trader which shows that just 2% of customers decided not to purchase a vehicle due to COVID-19 and only 16% felt apprehensive about funding before the end of June 2020.
Furthermore, the business quality is improving and over the past 17 months Auto Trader has made 2 key strategic decisions involving Cox and the acquisition of KeeResources, as well as growing its user base. With a quality management team with strategies aligned to the shareholder's best interest, appetite from equity investors should return.
Risks to the upside
There could be further economic deterioration arising from the COVID-19 lockdown leading to less consumer spending could prompt retailers to save on subscription costs to Auto Trader given their low single digit margins. This could deter future subscription fees from new clients who will need to save due to affordability issues arising from low margins.
eBay could make more strategic acquisitions to improve its platform, leading to a possible loss in market share for Auto Trader if their platform becomes superior and gains a larger network of users.
Market shocks from a possible second COVID-19 infection wave could lead to lower multiple valuations through investor panic. I think the consensus in the equity markets now is that a recovery is priced in given continual upswings in the FTSE 100.
There could be future corporate taxation to refund deficits created after enormous COVID-19 stimulus packages, leading to lower net income growth and cash generation for shareholders if Auto Trader pays more tax.
Auto Trader has a quality business model that has potential to improve given its apparent resiliency to the economic impacts of the virus. It also trades on a low multiple so a significant margin of safety is present due to the large difference between this multiple and the 6 quarter average. Investors should act quickly before this margin closes. eBay is way behind Auto Trader in terms of its reach of the cars it advertises to audiences and the extensiveness of its model, so catching up to Auto Trader seems unlikely as Auto Trader grows its moat through an expanding network of users. If the other aforementioned risks play out it certainly won't be the end of Auto Trader as car retailers will still want access to a great platform to stay competitive.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.