Carsales Impresses But Looks Expensive

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Carsales.com impressed brokers with a solid set of numbers in FY16 but several consider the stock expensive relative to the medium-term outlook.

-Strong dealer volume growth in second half
-OEMs still imposing restrictions but not overly contentious
-Meaningful progress in international required for more bullish outlook
 

By Eva Brocklehurst

Carsales.com ((CAR)) produced a strong result in FY16 while investment in Brazil is expected to provide earnings growth going forward and an uplift in South Korea, Chile and Mexico is also considered likely. A more detailed update is expected at the AGM in October.

Dealer revenues rose 10%, reflecting the impact of two price rises in used car listings and a 15% rise in new car listings, while private revenue rose 22.5% as the company consolidates the Redbook Inspect and Tyresales businesses.

The main surprise for Morgans was very strong dealer enquiries in the second half, represening the best volume growth in three years. Growth in depth products and pricing improvements continue to expand yields, the broker observes.

Morgans likes the business but the implied shareholder return suggested by its target of $13.01 is less than the 10% hurdle needed for an Add rating, and a Hold is maintained. Nevertheless, the broker would be a buyer on any weakness.

Despite Carsales' high quality domestic business and number one position in Australia, UBS maintains a Sell rating on valuation grounds and believes the stock is expensive relative to its medium-term growth outlook.

Brokers note the change in the competitive environment, with US-based Cox Enterprises becoming the primary shareholder in rival Carsguide.com.au, but remain confident in Carsales' strong brand. Morgan Stanley highlights the fact that the business has negotiated multiple challenges to its leadership position successfully over the years.

Earnings were lower than Deutsche Bank expected, primarily because of a weaker contribution from Stratton. Still, given Stratton is 50.1% owned the impact was less pronounced. Deutsche Bank expects the impact to be temporary. Meanwhile, international operations are considered to be tracking well, and Webmotors stood out with a 18% profit growth despite the subdued economic backdrop.

Management has confirmed recent issues with original equipment manufacturers (OEMs) imposing restrictions on advertising with third party sites. Carsales remains in discussions with them and expects the issues will be resolved. Given most OEMs seem to return to the fold after a withdrawal, the broker is not overly worried but will monitor inventory levels closely.

 Deutsche Bank views the introduction of Carsales' lead-based model as an important catalyst, with this model in place in Brazil and to be implemented shortly in South Korea.

Credit Suisse notes the solid progress in international markets but expects the monetisation process to take time and near-term earnings are likely to be affected by continued investment. Ord Minnett, too, expects upside from the international business but would prefer to witness more meaningful progress before pricing in a more bullish scenario and downgrades to Hold.

Stratton underperformed Ord Minnett’s expectations, even though earnings grew 36%, as volumes were hit in the fourth quarter as a result of a regulatory review of a preferred lender. This broker, too, expects the impact to be temporary.

The broker expects more modest growth in dealer revenue, with small yield increases while enquiry volumes appear to be maturing. Ord Minnett estimates private classified revenue was flat and the space is becoming increasingly competitive, although Carsales is well positioned.

The business performed better than Macquarie expected, particularly in regards to display advertising where the broker had envisaged growth might remain difficult. Moreover, domestic margins expanded to 60.8%, with operating leverage offsetting the drag which comes from a bias in growth to lower margin segments.

Macquarie also notes international trends are improving and expects this to provide a boost to medium term growth. The broker takes the opposite tack and upgrades to Outperform from Neutral.

There are two Buy ratings, four Hold and one Sell on FNArena’s database. The consensus target is $12.05, suggesting 6.9% downside to the last share price. Targets range from $10.00 (UBS) to $13.40 (Macquarie).
 

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