Questor: why Auto Trader’s road ahead looks promising as lockdown measures ease

A number of companies have prospered as a result of Covid-19 lockdowns. Among them are essential retailers and technology-focused businesses that have experienced rising demand for their products and services.

Now, a likely reversal of Covid-19 containment measures and a gradual reopening of the economy could create growth opportunities for other firms. One of these businesses could be the UK’s dominant digital automotive marketplace, Auto Trader, which Questor originally tipped as a “buy” in September 2018.

It has endured extremely challenging trading conditions in the past year as a result of containment measures and their impact on the wider economy. For example, new car registrations in 2020 declined by 29pc year on year, to their lowest level since 1992. Used car transactions fell by almost 15pc in 2020, as consumer confidence declined to its lowest level since the global financial crisis.

This resulted in a 37pc fall in the firm’s sales in the first half of its current financial year. Further declines in its second half, ending March 31, are likely, since ongoing lockdown measures have continued to disrupt the car-buying process.

In response, Auto Trader has strengthened its financial position. It raised £182.9m in an equity placing in April 2020 and also cancelled dividend payments. Its net bank debt position had improved by £217m so that it stood at £58m at its half-year results. The firm remained “substantially below” its covenant requirements for debt and interest cover in its early January trading update.

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The company has also helped its retailer customers to survive while trading conditions are tough. This has included heavily discounted advertising rates. Although they have compounded the firm’s poor performance in the short run, they also increase its chances of being ready to bounce back.

Judging by its performance following the end of the previous two national lockdowns, Auto Trader could deliver a sharp improvement in profitability as containment measures are eased. Indeed, in the second quarter of its 2021 financial year that coincided with the end of the first national lockdown, the company reported flat year on year profits.

Anticipation of buoyant trading conditions post-lockdown has gathered pace in recent months. The IMF forecasts that the UK economy will grow by almost 6pc this year. An increasing focus on environmental concerns may mean that a “green” recovery leads many consumers and businesses to switch from internal combustion engines to electric or hybrid vehicles. This could support stronger growth across the new and used automotive sector.

Auto Trader is well placed to capitalise on this growth opportunity. It has retained its dominant market position throughout the pandemic. Time spent by consumers on its website accounts for over 75pc of total minutes spent on all UK automotive marketplaces. Its market share is seven times greater than that of its closest rival.

It could also benefit from online retail trends that have accelerated during the pandemic. Consumers who previously had never, or rarely, used digital avenues when purchasing goods and services may now view it as a normal part of future transactions. This could move a larger proportion of the car-buying process online, thereby providing further growth opportunities for Auto Trader.

As was the case in our original tip, those growth opportunities mean that the company’s shares have a rich valuation. They trade on 28 times next year’s forecast earnings. At a time when unemployment is rising, consumer confidence is weak and much of the economy is closed, this may seem to be unrepresentative of the reality the firm currently faces.

However, Auto Trader’s financial position suggests it can survive present difficulties. Beyond that, a resurgent UK economy following the end of lockdown could significantly improve its financial performance.

Just as some businesses excelled during Covid-19, the reopening of the economy could provide a fillip for those that have struggled of late. In our view, Auto Trader’s dominant market position places it firmly in that bracket.

Questor says: buy

Ticker: AUTO

Share price at close: 585p

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