Car Dealer Issue Is Soft Growth, Not ASIC

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This story features EAGERS AUTOMOTIVE LIMITED, and other companies.
For more info SHARE ANALYSIS: APE
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

ASIC has automotive dealer finance commissions in its sights. Brokers are not overly concerned about these changes and suspect a softer growth outlook for automotive retailing is more significant.

-No changes to dealer volume bonuses and few changes to fees proposed
-Minimal impact envisaged for alternative distribution channels
-Slowing new car sales an item on broker watch lists
 

By Eva Brocklehurst

The Australian Securities and Investments Commission has proposed a ban on flex commissions for finance products offered in automotive dealerships. These are the commissions earned on arranging finance for prospective buyers of motor vehicles and linked to the interest rate on the loan. Lenders will need to change remuneration arrangements so that dealers are not incentivised by commissions to set interest rates.

There were no changes proposed to volume bonuses and no material changes to fees. The proposed changes are largely in line with the expectations of both AP Eagers ((APE)) and Automotive Holdings ((AHG)) and brokers suspect they have probably already made some adjustments in anticipation.

Nevertheless, while not expecting any material earnings impact for listed companies, Morgans believes that growing earnings in this area of automotive retailing is likely to be difficult for some time. Additionally, the broker notes a decision regarding the provision of insurance at dealerships is also in the eye of regulators, with an announcement expected shortly on that front.

Such regulatory constraints, in addition to a more subdued general automotive trading environment, means that several brokers are cautious about the earnings growth outlook for the sector. Credit Suisse is one, downgrading AP Eagers to Neutral from Outperform. The broker still expects earnings growth in FY17, but a slower pace than previously forecast.

There are other challenges besides the regulatory environment facing the industry, including slowing new car sales, while vendor expectations and increased competition mean material acquisitions in FY17 are unlikely. 

That said, the broker believes the company's strategy regarding Carzoos is excellent and consolidation in the long term is a theme that will benefit AP Eagers. Credit Suisse acknowledges a more rational supply environment could reduce further downside, around volume targets and incentive payments, but it is unclear whether this has changed materially and will actually drive upside.

At this point, Credit Suisse suggests lenders need to change remuneration arrangements so that dealers are not incentivised by commissions to set interest rates. The broker also observes that the finance rates at AP Eagers and Automotive Holdings are well below those highlighted by ASIC as being harmful to consumers.

In addition, there has been margin compression brought about by changing financier behaviour. Therefore, while not excluding some further negative impact and acknowledging the uncertainty and scope for change, Credit Suisse considers the assessment of the impact put forward by the companies is reasonable.

Moelis notes sale of finance is very high margin and plays an important role in dealer profitability. The broker expects sales staff will be remunerated more on a salary basis, as opposed to a commission basis going forward. This could provide another offset to lower income generated by financing.

In the case of AP Eagers, the broker reduces earnings estimates in the automotive division to capture the impact of marginally lower average interest rates. Moelis understands the company is a fairly lean operator and there is a risk the cost reductions may not offset weaker market conditions, while there is less growth likely from acquisitions. Carzoos had a slower than expected start, leading to a lower roll-out profile. Hence, Moelis expects less upside from this business in the near term.

The broker, not one of the eight stockbrokers monitored daily on the FNArena database, has downgraded its rating to Hold. Target price moves to $10.15. In the case of Automotive Holdings, the broker believes there are significant cost savings that can offset much of the impact of the cessation of flex commissions. Moelis has a Buy rating and $4.55 target.

Ord Minnett is positive about the ASIC decision, as it reduces regulatory uncertainty. While not anticipating a material impact, the broker does highlight a continuation of modest new car sales data and a particularly weak February. Citi also flags a soft trend in new vehicle sales, noting, in 2016 private purchases fell -6% and government purchases -1.4%, while business purchases grew 13%. Total passenger vehicle imports declined -8% in the December quarter.

While dealerships are the most affected by regulatory changes to commissions, Citi believes McMillan Shakespeare's ((MMS)) retail finance service has the most direct exposure of the leasing providers to the proposed changes in commissions. The broker envisages minimal impact to alternative distribution channels such as novated leasing. Nevertheless, given the end customer is also a retail consumer, there is a risk that the scope of changes is expanded to include this channel.

The second order impact from a reduction in these commissions is more relevant to the leasing and salary packaging companies, Citi contends, as it could result in dealers looking at other avenues to recoup lost earnings. The broker envisages minimal risk directly to the corporate fleet leasing businesses of Eclipx ((ECX)), SG Fleet ((SGF)) and McMillan Shakespeare.

The Changes

From September 2018, dealerships will be required to sell these products in line with the financier's rate. Dealers will be able to discount the lenders rate by up to 200 basis points, although potentially they earn less commission by doing so, but this allows some discretion to enable them to be competitive. The draft commencement date for the cessation of flex commissions is slated for September 1, 2018.

Lenders would be solely responsible for nominating an interest rate and this would enable them to set rates according to their assessment of the risk of the transaction. While not banning origination fees, the new regulations will require lenders to set a maximum price for these fees and stipulate that intermediaries cannot vary the price according to factors unrelated to the services provided. The 18-month transition period is proposed to enable the industry to develop new pricing models and re-negotiate remuneration arrangements.

FNArena's database has four Hold ratings for AP Eagers. The consensus target is $10.00, suggesting 4.7% upside to the last share price. Targets range from $9.40 (Morgan Stanley) to $10.59 (Morgans). There are four Buy ratings, one Hold and one Sell for Automotive Holdings. The consensus target is $4.20, suggesting 6.3% upside to the last share price. Targets range from $3.15 (Morgan Stanley) to $4.60 (Deutsche Bank).
 

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