Is Carsales Slowing Down?

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Online automotive business Carsales.com posted a messy first half result, leaving brokers questioning whether earnings momentum is losing traction.

-Long-term potential in international market but domestic performance key to short term
-Global technology players becoming more active in the company's market segments
-Stratton not out of the woods yet, although not expected to deteriorate further

By Eva Brocklehurst

Is earnings growth becoming harder for Carsales.com ((CAR))? The company's first half results were underpinned by growth in the dealer segment, resilience in display advertising and rapid growth for Tyresales and Redbook Inspect. Yet higher costs appear to have put a brake on growth.

Carsales may be a very good digital company but Morgan Stanley believes incremental growth in earnings per share is becoming harder, and the first half growth of 5% will not be sustained by the current price/earnings ratio of 22x.

The broker suggests the growth rate and contraction in the first half EBITDA margin indicate a maturing business and increasing competition. A maturing business reflects the migration from print to online. This signals the key to growth will be bolt-on acquisitions, such as Tyresales, Stratton & international assets. High growth but lower quality earnings in the broker's view.

As well, Morgan Stanley believes global technology players are becoming more active. This includes eBay and Gumtree, which have already negatively affected the company's traditional price increases in its private seller division. Facebook and Google/YouTube have also crimped the broker's growth expectations for Carsales.com's display advertising.

The risk is, if growth cannot return to double digits, a price/earnings de-rating is likely. Morgan Stanley maintains a Overweight rating at this point, noting the recent weakness in the share price reflects some of its concerns.

UBS concludes that the shape and risk profile of forward growth appears to be less attractive versus history yet the stock remains inexpensive relative to the past. The upside risks to the broker's forecasts relate to whether the company can sustain around 10% annual revenue growth in the dealer business through a combination of price and depth measures, and obtain growth in non-core domestic streams.

On the other hand, downside risk looms with heightened competition and a limited dealer profitability pool. All up, the broker considers the stock to be fairly valued after its rebound and maintains a Neutral rating.

Citi expects an acceleration in revenue growth in the core business and growth rates to be maintained in the longer term, driven by both volume and yield in the dealer business. In the international market the broker acknowledges long-term potential but does not believe this will make a meaningful contribution in the near term. Hence, Citi's Buy rating is based on the performance of the core domestic business.

Stratton Subdued

Macquarie was encouraged by the revenue trends, including the dealer category, where contributions were made from depth revenue, price increases and volumes. As expected, Stratton revenues were negatively affected by supplier issues. The broker expects a gradual re-basing as this business adjusts its operations and cost base to account for recent disruptions.

Stratton will probably face additional challenges, should the industry need to adjust its practices regarding insurance add-ons and/or flex commissions. Nevertheless, the broker envisages scope for better earnings momentum in the second half.

The first half reflected higher marketing spending which, partly a timing issue, is expected to taper off in the second half. Macquarie notes this is the last result that will be delivered by co-founder and CEO Greg Roebuck following his retirement. The broker does not expect any shift in strategy with the new CEO, Cameron McIntyre, who is the current chief operating officer.

Management remains positive on the differentiation that the Redbook Inspect service can provide. Margins will be inferior to the core business but the broker still expects the contribution to be positive and improve as the business scale increases.

Morgans maintains a Hold rating and notes, but for the problems at Stratton, underlying earnings would have increased almost 14%. Assuming Stratton does not get any worse in the second half, although unlikely to improve, there are reasonable prospects for high single digit growth in earnings per share from FY18 onwards, in the broker's opinion. Stratton Finance was affected severely by one of its main suppliers of loans falling foul of the corporate regulator, ASIC, and management has signalled that the second half will not be that much better.

Competition Increasing

This is one of the weakest half-years to date Morgans observes, as the core business chugged along nicely, albeit with elevated costs, while more recent add-ons such as automobile finance and Asian classifieds cut around $10m out of the headline result. The broker has a long-term positive view on the stock, as the company dominates online automotive advertising and is unlikely to be toppled by a new entrant, albeit major competitor Carsguide is being re-launched under a new owner, Cox, which has deep pockets.

History does not favour weak number two players in online classifieds, Morgans asserts, yet Cox is a huge company with a successful business in the US. Hence, caution prevails regarding the impact of competition on Carsales in FY18 and FY19.

Is The Business Riskier?

Ord Minnett expects the increase in the dealer lead fee and the strength in data & research will offset the ongoing challenges in Stratton in the second half and once again deliver a quality result, while the company invests the growth in emerging businesses and highly prospective international options.

The broker notes the acquisition of DeMotores rounds out the company's Latin American exposure and, combined with the Asian investments, calculates $1.10 in value embedded in the share price. Stripping this out this reveals a core FY18 price/earnings ratio of 18.6x. With the businesses at an early stage and with some development costs borne by the core business, the broker believes there is considerable potential for growth.

Despite the solid performance, Deutsche Bank is more cautious and lowers its forecasts to reflect lower earnings at Stratton and the macro conditions that are affecting Webmotors in Brazil. Webmotors moved to a lead-based model from July 2016 and, while first half dealer leads were up 41%, this failed to translate to a meaningful revenue uplift. Weak macro conditions in Brazil are having an impact, the broker observes.

Elsewhere, Shaw and Partners notes the company's investments in infant markets have attractive earnings potential. This includes Argentina, Mexico and Chile. Nevertheless, these are medium-term propositions, which the broker believes makes the stock a much riskier investment than it was. Lower margin businesses are taking a greater portion of earnings growth and this is a key risk for the future.

The broker has a target of $11.50, which incorporates a demanding multiple with increased earnings risk and lower earnings growth relative to the company of old. Shaw, not one of the eight stockbrokers monitored daily on the FNArena database, has a Hold rating.

Credit Suisse was particularly encouraged by the 10% growth in dealer revenue and expects the core domestic revenue growth to continue strongly. The broker does not believe the stock is expensive as it trades at the low end of its peer group range, retaining an Outperform rating.

The database shows five Buy ratings and three Hold. The consensus target is $12.05, suggesting 10.7% upside to the last share price. Targets range from $10.50 (UBS) to $13.20 (Macquarie).
 

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