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Questor: despite tough markets, there should be more in the tank for Inchcape. Hold
Questor share tip: the car distributor is redirecting its cash to where returns are best, while there is a decent 4pc yield
A quick way to lay your hands on some ready cash is to trade in the motor. Inchcape operates in 32 markets and knows plenty about the automotive business, but is hardly in need of fresh funds. So why is the FTSE 250 car distributor – whose net debt level remains undemanding even after its adoption of new IFRS 16 accounting standard – selling off dealerships?
The answer is capital allocation: driving Inchcape’s resources where they can be most useful while the car market remains tough and uncertain. Last week the firm disposed of three retail sites in Australia, on top of three more announced earlier in the year.
The six will yield cash proceeds of £76m and amount to two thirds of the group’s retail arm in that country but they contributed a measly £300,000 in earnings in the first half of the financial year.
Stefan Bomhard, Inchcape’s chief executive, has also been cutting back on retail in Britain, where the switch from polluting diesel vehicles has hit the market hard. Russia and emerging markets are performing better.
The car industry requires careful navigation from investors. Stories abound that the world has passed “peak car” and that sales will decline from here, that the industry is vulnerable to tariffs and consumers are avoiding big-ticket purchases.
Certainly change is on the way, as better electric and driverless cars are developed. Yet shares in Auto Trader have proved to be a very good bet for us and Johnson Matthey, the catalytic converter supplier, is showing a decent gain since we tipped it here at the start of the year.
However, it has been a rocky road for Inchcape, a historic trading company that traces its roots back 170 years, since Questor recommended the stock last summer. Bearish surveys of new car sales in the company’s end markets have tested City confidence in the firm. In Australia, one of its key markets, the dollar weakening against the yen pushed up the price of imported Subarus for Sydneysiders.
Last year was one to forget, as group profits slumped by two thirds. Even in the first half of this year, trading profit at its distribution division, which accounts for 90pc of profits, contracted by 12pc and the margin shrank to 7pc. It was a mixed picture: the Baltic region was strong; Chile was not. The second half is predicted to be better, with supplies into Australia and Ethiopia improving.
Company followers at JP Morgan Cazenove, the broker, expect operating profit to dip to £376m this year but bounce back to £389m next year.
It sounds like Inchcape has chosen an exotic collection of markets to operate in, which is precisely the point. The company goes where the major car marques want a presence but prefer someone else to handle everything from logistics to aftersales, marketing and planning.
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It has key relationships with Toyota, Lexus and Jaguar Land Rover, among others, and favours the premium end of the market, where sales have held up better.
There are high barriers to entry in small markets, and some relationships go back decades. Mr Bomhard, who is squeezing costs and cutting capital expenditure, has also shown a willingness to expand: he is investing in distribution in Lithuania and Kenya to shore up the firm’s relationship with BMW. The theory is that disruption from electric cars will occur later outside major markets.
Inchcape throws off plenty of cash and offers a decent 4pc yield. Debts are low. Analysts at Zeus Capital think there is around £1bn in financial firepower that can be deployed in share buybacks and acquisitions over the next two years or so. A £100m share buyback is currently under way.
The shares have enjoyed a rally over the past month. Despite tough markets, they looked oversold. A further focus on distribution and reduction in retail could improve their appeal. Trading at 10.2 times this year’s forecast earnings, there should be more in the tank.
Questor says: hold
Ticker: INCH
Share price at close: 650p
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