My family’s trusted second car finally blew its gasket (literally) after 15 years of use. Begrudgingly, I started researching new cars and eventually went to a dealership.
Business seemed slow. Very slow. Hardly any customers were in the store, despite a generous promotion and the financial year-end, normally a busy time for car sales.
I benefited. The car dealer offered free auto and other upgrades. And the small SUV I bought, a demo model that had done only a few kilometres, was reduced by $3,000. When they offered more than I expected for my worthless trade-in, I was ready to do the deal.
Unprompted, they offered another $1,000 off the car. By my count, the car was reduced by almost a quarter from its full sale price.
Perhaps I got lucky. After the sale, the assistant told me business was unusually slow and they were under pressure to move stock. When I spoke to him recently, he said business was still tough. The boom in new car sales was well and truly in reverse.
New vehicle sales fell 5.5 per cent in September nationally, compared to the same time a year ago. Remarkably, passenger car sales slumped 20.5 per cent year on year. The fall was most pronounced in New South Wales, which is experiencing the largest property price falls.
The link between house prices and car sales is telling. Rising car sales normally follow rising house prices. When home owners feel wealthier on paper, they tend to spend more. Many borrowed against rising equity in their house to buy a trendy sport utility vehicle (SUV).
With house prices falling sharply in Sydney and to a lesser extent in Melbourne, the car sales trend has turned sharply. When people feel less wealthy, or are worried about the falling value of their house, heavy debt and sluggish wages growth, a new car purchase is easy to defer.
I follow car sales closely because they are a useful early indicator for the economy and a gauge of consumer sentiment. Right now, falling car sales suggest weakening consumer confidence and an economy that may not be as strong as the Reserve Bank suggests in the next two years.
The market is well aware of these trends. Automotive Holdings Group, owner of many car dealerships across Australia, has a one-year total return (including dividend reinvestment) of minus 43 per cent. The stock has almost halved from its 52-week high this year.
Rival AP Eagers has done better, down 5 per cent over 12 months. But a 3-year average annualised return of almost 10 per cent shows how tough conditions are.
Luxury car dealership AutoSports Group, a 2016 Initial Public Offering, has a one-year total return of minus 30 per cent. Motorcycle dealership network MotorCycle Holdings is down 50 per cent over 12 months, after initially starring after its 2016 float.
Each company faces a common challenge: sharp falls in new car and motorbike sales and the prospect of more to come as the property downturn accelerates in the next 12 months. It’s hard to find a catalyst for a recovery in car sales – and car stocks – given these trends.
But every stock has its price. The market is factoring much bad news into car stocks and may have over-reacted at current prices. Yes, conditions are tough in the car industry and likely to stay that way for at least the next year. But the medium-term outlook is still okay.
Population growth is a tailwind for the sector because more people means more cars are needed. City densification, longer commute times and extra wear and tear on cars are good for the sector as people are forced to replace or upgrade cars earlier than they otherwise would.
Consumers might delay car purchases this year and next, but it cannot stay that way for too long. At some point, cars have to be replaced and it is a reasonable bet that new car sales per capita will be back at their long-run average within two to three years. Persistently low interest rates will eventually tempt consumers.
So, is it time to take a contrarian view and buy car stocks?
For the most part, no. I expect further falls in car sales and weakness in most car stocks. I am becoming more bearish on property prices and expect that downturn to have a larger effect on new car sales. Fewer consumers will be able to borrow on a whim to buy a fancy car, thanks to the Financial Services Royal Commission and its effect on lending standards.
The big risk is that new-car weakness leads to irrational market behaviour: crazy discounting or other promotions that hurt profit margins across the industry. I benefited a little from that irrational behaviour, given the speed at which the dealer was willing to discount.
Caveats aside, Automotive Holdings Group (AHG) looks interesting at the current price. It has the size and scale to withstand the downturn and snap up weakened competitors. It offers a mix of brands, meaning it is well placed to capitalise on car launches and new models with upgraded technology that stimulate demand and get buyers back into car showrooms.
AGH’s valuation is its biggest selling point. At $1.99, the stock is on a forecast Price Earnings (PE) multiple of about 10 times, which is hardly demanding for a sector leader. A fully franked yield of 6.4 per cent, based on consensus analyst forecasts, appeals.
Morningstar’s fair-value estimate of $2.80 suggests AGH is materially undervalued at the current price. The research house expects further weakness in new car sales and has downgraded earnings forecasts for AGH, but believes its price has fallen too far.
A share-price target of $2.36, based on the consensus of 10 broking firms, also implies AGH is undervalued at the current price. The consensus view looks reasonable: AGH is not a screaming buy in the short term, but there’s emerging value for experienced investors with a 3- to 5-year view who know the best time to buy is usually when the market overreacts to bad news.
Chart 1: Automotive Holdings GroupSource: ASX
• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at November 6, 2018.