It's 'feel good' time among major dealer groups as buoyant car sales generate bigger profits and higher share prices. But amid the current flurry of takeovers, investors need to be cautious about interest rate trends. And initial conclusions that changes to Block Exemption favour dealer PLCs at the expense of manufacturers may not be as clear-cut as they seem. Report by Arthur Way.

These are good times for the UK's public limited companies (PLCs) involved in vehicle distribution. Favourable circumstances have created a mood of optimism which, on the evidence of recent and current performance, is well justified. Many groups are reporting strongly rising sales and profits, accompanied by upbeat assessments concerning future prospects. A typical example is provided by Pendragon, the country's largest vehicle distribution group, whose mid-February figures showed that operating profits increased by an impressive 54% last year. At the pre-tax level the profits advance was almost eightfold thanks to exceptional items including property disposals, while the underlying strength of the business was reflected in margins reaching a five-year high of 2.8%. The sector's good news is expected to continue as other companies release their past year's financial results over the next few weeks.

A recent announcement from European Motor Holdings indicated that the company was very encouraged by the progress made during its latest financial year to the end of February. When figures are released at the end of April it is probable that profits will have exceeded analysts' estimates of £9.5m by a modest margin. Already EMH, along with others including Lookers and Reg Vardy, have reported a rising profits trend during the first half. A key factor, of course, is the buoyant state of new car demand. The market has been bolstered by positive economic indicators and, in particular, the drop in interest rates which has provided a powerful boost to consumer and business confidence. A critical element is the greater presence of high-margin private buyers who have been enticed back into the market by falling list prices along with attractive finance and warranty packages. To some extent this has nullified the threat from on-line car retailers who, so far, have failed to make a serious impact on traditional franchised dealers, although they are lurking in the background and are poised to become a more significant threat. In addition, some of the more actively managed PLCs have helped themselves by implementing a variety of restructuring moves aimed at cutting costs.

An important element in this regard has been the takeover of other dealers in order to exploit synergies while at the same time disposing of poorly performing assets. Again, Pendragon is a good example. During the past year the company has placed a greater emphasis on upmarket marques such as Aston Martin, Jaguar and Land Rover while reducing its exposure to low margin volume brands and marginal suppliers like Mazda and Suzuki. Moreover, the company has moved from being a purely parochial distributor in the UK to assuming an increasingly international stance with operations in Germany and the US. Adding to this overall 'feel good' factor, it is generally accepted that the major PLC distribution groups will be the principal beneficiaries from proposed changes to Block Exemption.

According to industry analysts, the balance of power will shift from manufacturers to dealers - and, especially, the larger groups - once the revised system is up and running. According to this view, manufacturers will have less influence over the commercial strategies of their distributors who, in turn, will be able to pursue business opportunities without fear of manufacturer reprisals. Meanwhile, the larger groups will be able to derive above average cost savings and thereby raise competitiveness through exploiting their greater economies of scale. With this background it is unsurprising that share prices of UK dealer groups should have been so frisky.

Although not a sector normally favoured by investment managers, there has been growing interest recently, notably among some of the specialist funds which invest in smaller UK companies. In addition to the sector's strong fundamentals - and, especially, the continuing exuberance of new car sales - fund managers have been attracted by the prospect of securing capital gains as the sector consolidates and further takeovers occur. As the accompanying table indicates, in mid- February five of the 13 companies with a stockmarket quotation were standing at a 52- week high, while all the others were only just below their high for the year. Latest developments indicate that investors have been right to await acquisition activity. Following closely on UnitedAuto Group's purchase of Sytner during the first half of February, Quicks became a bid target. Action was triggered when Guinness Peat sought a further 9.1%, stake in the company, bringing its holding to almost 30%. At the time of going to press, CD Bramall - which has also built up a sizeable stake in Quicks, believed to be around 29% - was also reported to be on the verge of making a bid for the Manchester based group.


"Longer term, there is considerable uncertainty over the precise effect that the Block Exemption revisions will have on the structure of the market and the prospects for participants "

Clearly, the cocktail of rising profits and takeover activity is a potent one, but it remains to be seen how long this rosy sentiment on the part of investors persists. A review of vehicle distribution over the past 20 years indicates that the sector's fortunes conform to a strongly cyclical pattern which causes wild fluctuations in the share prices of the publicly-quoted groups. Notwithstanding the strong sales start to the year, along with the possibility of a further boost when the registration plate changes in March, there are several impediments on the horizon which are likely to affect companies' prospects and therefore investors' leanings. It is widely forecast - by even the motor industry's most enduring optimists - that new car demand in the UK will ease during the present year which suggests softening margins as manufacturers and dealers attempt to maintain volumes. This is all the more probable if the forecast of higher interest rates by the end of the year holds true. Longer term, there is considerable uncertainty over the precise effect that the Block Exemption revisions will have on the structure of the market and the prospects for participants.

For a start, it is difficult to believe that vehicle manufacturers will simply sit back and allow the balance of power to tilt towards the principal distribution groups without a struggle. All of them are only too well aware of the impact that the concentration of power in food retailing has had on food manufacturers with Asda, Tesco, Sainsbury and one or two others able to dictate terms. In the attempt to prevent the same occurring in motor retailing, vehicle manufacturers have several key initiatives under development which are likely to be implemented on an increasing scale during the next few years. Some are already in evidence, such as an extension in ownership of franchised networks, while others include using motor shows as an order-taking opportunity and the development of direct selling, perhaps linked to finance and leasing packages. Surely it is also premature to dismiss the potential of the smaller, privately owned dealers. In much the same way that the internet has empowered small businesses to access world markets, the provisions of Block Exemption will expand the horizons of even the smallest single-site outlet. With a determined entrepreneur at the helm it is easy to imagine an operation with one or several sites achieving a significant impact on a wide geographical front, the more so as greater sales lead to bigger 'fleet' discounts from manufacturers. Another wild card arises over the entry of outsiders into the retail motor trade.

The proposed revisions to Block Exemption provide strong encouragement for nontraditional retailers to strengthen their positions. Even though internet retailers may still have to source their vehicles from the 'official' franchised network it is difficult to believe that supply will be a problem. Indeed, supplies should free up considerably in the context of the new freedoms for dealers, and many of the aforementioned smaller groups will be keen to supply in order to expand their volumes and boost manufacturer discounts. Moreover, supermarket groups will be able to effect an easy entry into the marketplace if they desire through purchasing an existing dealer group. Apart from Inchcape which is capitalised at over £0.5bn, none of the other groups command a stockmarket valuation which the major retailers would consider more than small change in the context of their capital expenditure programmes. However, perhaps the biggest threat to the wellbeing of the PLCs arises over the proposed split between sales and servicing and, particularly, the rights of independent repairers to have access to technical information and parts. Parts and servicing have been critical in maintaining profitability during times of falling vehicle sales but, under the revised Block Exemption proposals, it would be wise to anticipate the arrival of a new breed of cutprice servicing chains - the easyJet and Ryanair of the aftermarket - with the potential to cause serious damage to existing players.

Maybe the conditions are right for the continuing success and growing dominance of the major distribution groups and perhaps the advantage will shift from manufacturers to dealers. At the very least, though, the industry is entering uncharted waters in which the capacity for new thinking and upsets appears considerable. In such a volatile business environment it would be careless to believe that conventional wisdom is an infallible guide to the future and, on the basis of present evidence, it is hard to avoid the conclusion that the managements of both Sytner and Quicks are doing the right thing for shareholders by selling out at the top of the market.

 

Share Price Performance of UK Dealer Groups

 

Price in pence (Feb 15, 2002)

52-week High

Low

Market Capitalisation (£m)

CD Bramall

295

295

102

110.9

Caffyns

458

458

300

15.5

Dixon Motors

209

225

147

76.0

European Motor

119

121

60

63.8

HR Owen

170

171

100

31.9

Inchcape

684

686

275

529.8

Jacks (Wm)

95

95

38

10.4

Lookers

140

144

76

47.5

Pendragon

310

310

170

183.6

Quicks

84

85

50

33.7

Ryland

87

88

46

25.6

Sytner

340

342

105

91.7

Vardy (Reg)

391

391

237

225.7