{"id":2287,"date":"2020-03-15T18:57:11","date_gmt":"2020-03-15T18:57:11","guid":{"rendered":"http:\/\/frugalstudent.co.uk\/?p=2287"},"modified":"2020-03-15T21:07:16","modified_gmt":"2020-03-15T21:07:16","slug":"coronavirus-opportunities-autotrader-group-plc","status":"publish","type":"post","link":"https:\/\/frugalstudent.co.uk\/index.php\/2020\/03\/15\/coronavirus-opportunities-autotrader-group-plc\/","title":{"rendered":"Coronavirus opportunities: AutoTrader Group PLC"},"content":{"rendered":"

Finally, fear has returned to the markets and I can once again think about going shopping.<\/span>\u00a0<\/span><\/p>\n

Whilst it\u2019s true to say that markets are still lofty, we can never predict its future movement – as such softly accumulating at these levels is not a bad idea.<\/span>\u00a0<\/span><\/p>\n

As buffett<\/p>\n

Over the past week I have used 1\/4 of my dry powder to add to current positions to my portfolio, I also have a fair few companies on my watchlist.\u00a0<\/span>\u00a0<\/span><\/p>\n

A company I have had my eye on for a while is\u00a0<\/span>AutoTrader<\/span>\u00a0Group PLC, a classically boring company that holds a near monopoly over car sales listings in the UK.\u00a0<\/span>\u00a0<\/span><\/p>\n

Trading at a P\/E of 21 at the time of writing even after a 25% haircut from the market, it may appear over-valued at first glance but given it has returned to levels last seen in November 2019, it\u2019s worth a closer look.<\/span>\u00a0<\/span><\/p>\n

Summary<\/b><\/span><\/p>\n

AutoTrader Group Plc is an online only company that offers a digital marketplace for individuals and businesses to buy and sell new or used cars online.\u00a0<\/span>\u00a0<\/span><\/p>\n

Traditionally a printed publication shipped out to all parts of the UK, the management has been able to effectively transition the business to an online-only model which has effectively removed costs from the business.<\/p>\n

AutoTrader Group Plc generates revenue through charging private sellers and car retailers to list cars on their website.<\/span>\u00a0<\/span><\/p>\n

Economic Moat<\/b>\u00a0<\/span><\/p>\n

As a business perspective investor, the first thing I like to do when considering a potential investment is to take a step back and to consider the underlying dynamics of a company.<\/p>\n

I usually try to answer the following questions which usually hint towards the existence or lack of economic moat.<\/p>\n

Does this company have to compete fiercely with competitors?<\/strong><\/p>\n

If this company raised prices by say 5%, would people switch to a competitor or stay put?<\/strong><\/p>\n

Can this company pass on any supply side cost increases to customers?<\/strong><\/p>\n

After asking these questions and investigating the likely responses, I concluded that\u00a0AutoTrader Group Plc possesses a wide economic moat.<\/span><\/p>\n

But where does this moat come from?<\/p>\n

The moat is derived from two sources.<\/span><\/p>\n

Firstly a network effect stemming from their dominance of online car advertising in the UK with 85% of all adverts being posted on their platform. <\/span><\/p>\n

Secondly, the moat is\u00a0<\/span>entrenched further by\u00a0<\/span>AutoTrader\u2019s<\/span>\u00a0heavy investment in data services which means it provides buyers and sellers with unmatched information on selling prices and vehicle history.\u00a0<\/span>\u00a0Such a large database of information and sales history forms an intangible asset difficult for competitors to replicate. This data-trove was further\u00a0bolstered by AutoTrader’s\u00a02019 acquisition of vehicle data company\u00a0Keeresources\u00a0Ltd. The utilization of this data creates an unrivaled user experience both informing and empowering consumers.<\/span><\/p>\n

For example, the listing below lets the buyer know that the listed car is priced fairly but is \u00a3513 above the market average. I believe only\u00a0<\/span>AuoTrader<\/span>\u00a0would have a database of selling prices large enough to present such information accurately, further\u00a0<\/span>widening it\u2019s moat.<\/span>\u00a0<\/span><\/p>\n

\u00a0\"\"<\/span><\/p>\n

The effects of the moat are clear: Sellers<\/span>\u00a0want to sell on\u00a0<\/span>AutoTrader<\/span>\u00a0because it attracts the most eyeballs and buyers want to search for cars on\u00a0<\/span>AutoTrader.co.uk<\/span>\u00a0because it attracts the most listings. The price paid for advertisements doesn’t really come in to the equation.<\/span>\u00a0<\/span><\/p>\n

Whilst it is my view that the best moats can be identified easily by glancing over a business and thinking about it rationally, many readers like this perspective backed up by the numbers, so let\u2019s look.<\/span>\u00a0<\/span><\/p>\n

My favorite measures for the existence of an economic moat are gross and operating margin. <\/span><\/p>\n

Although not always true, the existence of high gross margin figures and high operating margin figures usually indicates the existence of an economic moat (I tend to look for >80% and >20% respectively).<\/span>\u00a0<\/span><\/p>\n

This is because it indicates that a company may not have to cut its margins in order to compete.\u00a0<\/span>\u00a0<\/span><\/p>\n

I wasn\u2019t able to find costs of sales figures for\u00a0<\/span>AutoTrader<\/span>, but operating margin figures against revenue displayed below shows that\u00a0<\/span>AutoTrader<\/span>\u00a0shows all the signs of a ‘<\/span>moaty’<\/span>\u00a0business. As revenue has increased so has operating margin indicating increased efficiency and the success in growing revenue without cutting prices.<\/span>\u00a0<\/span><\/p>\n

These are the best types of businesses – ones where new revenue flowing through the business increasingly trickles through to the bottom line.<\/strong><\/p>\n

\u00a0\"\"<\/span><\/p>\n

 <\/p>\n

We can also turn to the company\u2019s Capital Expenditure figures just to ensure that there isn\u2019t any income statement manipulation going on. <\/span><\/p>\n

Sometimes, it\u2019s possible for companies to display very high operating margins by capitalising normal business expenses thus removing them from the income statement.<\/span>\u00a0<\/span><\/p>\n

With Capex consistently under 2% of operating profit, we can confirm that this is not a risk.<\/span>\u00a0<\/span><\/p>\n

 <\/p>\n

Utilization of free cash flow<\/b><\/span><\/p>\n

One sign that\u00a0<\/span>AutoTrader<\/span>\u00a0Group PLC may not merit\u00a0<\/span>its 22P\/E ratio is that it appears management may be running out of ideas to put capital to good use.<\/span>\u00a0<\/span><\/p>\n

A key indicator of this is the increased allocation of capital to share repurchases and dividend payments.<\/span>\u00a0<\/span><\/p>\n

\u00a0<\/span>As evidenced in the graph below, in 2018 a concerning 78% of the \u00a3189m generated in free cash-flow was eaten up by share repurchases and dividend payments.<\/span>\u00a0<\/span><\/p>\n

\"\"<\/p>\n

Whilst buying back shares and paying dividends rewards investors, one would expect more allocation of resources to growth opportunities given how the market is currently pricing\u00a0<\/span>AutoTrader Group PLC’s stock<\/span>.<\/span><\/p>\n

Let me emphasize<\/strong>, I am a lover of share repurchases as they increase an investor’s ownership stake in a company.<\/p>\n

In fact, I have applauded Next PLCs buybacks on several occasions.<\/p>\n

BUT<\/strong> a company buying back shares at a P\/E <15 is different to a company buying back shares at a P\/E of >20.<\/p>\n

To me, share repurchases should be reserved for mature companies trading at reasonable valuations not for companies that grew EPS by 10% in the previous year.<\/p>\n

Considering these figures with the very small capital expenditure spend, it may be the case that growth is running out and thus 22 p\/e is a price not worth paying.<\/span>\u00a0<\/span><\/p>\n


\nLooking into my crystal ball \u2013 a fair value estimate<\/b>\u00a0<\/span><\/p>\n

Ultimately, a company is worth all of it\u2019s future cash flows discounted back to today\u2019s value considering the time value of money.<\/span>\u00a0<\/span><\/p>\n

Considering the future growth paths for\u00a0<\/span>AutoTrader Group PLC<\/span>, I will conservatively estimate earnings growth of 12<\/span>% over the next 3 years dropping to 10% over years 4-6 then reducing to a normal growth rate of 3.5% into perpetuity.\u00a0<\/span><\/p>\n

The basis of these estimates are previous organic growth, analyst estimates and an assumption of a 2% per year reduction in the share count (2.6% between ’16-’17, 2.8% between ’17-’18, 2% between ’18-’19).<\/p>\n

I will use a discount rate of 9% reflecting the relative safety of earnings and the record low risk free rate in the UK.<\/p>\n

As I am happy that there is no earnings manipulation happening, I used EPS as the basis of my calculation.<\/span><\/p>\n

The calculation resulted in a Fair Value Estimate for Autotrader Group PLC of \u00a33.98 per share.<\/p>\n

As such precise calculations are intrinsically flawed as they rely on human judgement, I like to assign a fair-value range to stocks in order to include a margin of error of the exact calculation.<\/p>\n

Giving a 5% margin for error on either end, a fair value range for AutoTrader Group PLC would be between \u00a33.78 and \u00a34.18 a share.<\/p>\n

\"\"

Red line = Fair Value<\/p><\/div>\n

In closing<\/strong><\/span><\/p>\n

Quality businesses such as AutoTrader are usually tough to buy at around fair value. As such, even though AutoTrader Group PLC’s shares appear to be around 12% over-valued, this is based on conservative estimates and it may be worth opening a very small position at these levels.<\/p>\n

Why?<\/p>\n

I have passed up several opportunities in the past for being ‘over-valued’ based on discounted cash-flow and dividend models and most have gone on to materially outperform. Experience tells me that high-quality cash generative businesses tend to remain ‘over-valued’ on traditional measures.<\/p>\n

I sometimes refer to this as a ‘wide moat premium’<\/p>\n

FrugalStudent Verdict: HOLD (Add lightly at \u00a34.18, add heavily under \u00a33.78)<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

Finally, fear has returned to the markets and I can once again think about going shopping.\u00a0 Whilst it\u2019s true to say that markets are still lofty, we can never predict…<\/p>\n","protected":false},"author":1,"featured_media":2294,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[],"_links":{"self":[{"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/posts\/2287"}],"collection":[{"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/comments?post=2287"}],"version-history":[{"count":4,"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/posts\/2287\/revisions"}],"predecessor-version":[{"id":2297,"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/posts\/2287\/revisions\/2297"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/media\/2294"}],"wp:attachment":[{"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/media?parent=2287"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/categories?post=2287"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/frugalstudent.co.uk\/index.php\/wp-json\/wp\/v2\/tags?post=2287"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}