AUTO bought

This week stock markets continued to rebound globally following the period of volatility earlier this year. Most of the stocks in my portfolio had a good week, though the overall performance was held back by a veiled profit warning from On the Beach, one of my larger positions.  

I’ve been successfully avoiding profit warnings for over a year, so was disappointed to finally hit one. It wasn’t immediately clear to me that On The Beach’s interim results constituted a profit warning and I was consequently a bit slow in selling, leaving it to the day after the update after the price had rebounded a little from its earlier 16% fall. I made 10% profit on the trade over just a few months, though I had high hopes for On The Beach so am disappointed that this was not more.

The outlook statement:

Given the resilient and flexible nature of our business model, the Board remains confident in delivering a full year result in line with management’s expectations, taking into account the one-off impact of flight capacity constraints as a result of the Monarch failure and the accelerated investment to support International growth.

My main concern is that the statement seems significantly more downbeat than the AGM trading update in February, where management were dismissive of the impact of the Monarch failure and suggested it would not affect ability to meet expectations. I’m not at all a fan of the weasel words in the current statement: ‘in line with management’s expectations, taking account […]’. While the tone is still pretty positive and management seems genuinely optimistic about summer trading, it is clear that performance so far has not quite lived up to expectations and that expectations for the full year are being lowered. The long term growth story still seems intact, though I think the risk of a further profit warning this year has risen. I’ve lost a bit of confidence in this one and there are plenty of other fish in the sea.

Barring this glitch, everything else is looking pretty positive. The watchlist as a whole is looking bullish – 53 of 100 shares are within 5% of their highs and 74 are within 10%. I’ve continued to reinvest my cash balance and am now near fully invested, except for a small amount I’m keeping dry to take advantage of any opportunities.

One of the shares on my watchlist, ZPG, was subject to a takeover bid this week, at a 30% premium to the prevailing price. Takeover activity seems to have been picking up recently, and quality UK assets are currently looking particularly attractive with the low Pound. Increased takeover activity and rising market volatility are signs that weakly indicate the market could be near highs. The more times the market recovers from temporary dips, the easier it is for investors to start to get complacent and assuming the only way is up. That said, given the favourable global economic conditions, I reckon the market has probably got another spurt or two left in it, or even a bubble of some sort. While I’m remaining wary, I don’t think it’s the right time for any evasive action yet. As Peter Lynch famously said: ‘Far more money has been lost by investors preparing for corrections, or in anticipation of corrections, than in corrections themselves’.

As the Pound has been falling, I’ve been getting more interested in UK based businesses. Following my purchase of Howdens Joinery last week, I’ve bought another reasonably priced quality UK-focused share this week to replace On The Beach – Auto Trader.

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Auto Trader

As I am sure readers will be aware, Auto Trader provides an online marketplace for buying and selling cars. The company has been around for a long time. Originally a magazine with classified advertising for used cars, it was the first to seriously develop an online platform in the UK and has dominated that space ever since.

It is super-profitable and is what I like to think of as a ‘money-printing’ business – one that can continue to make big profits for some time without really needing to do anything. My two largest current holdings are other examples of ‘money-printing’ businesses: Bioventix, which earns royalties from blood tests involving antibodies it has previously developed, and Mastercard, which earns a small transaction fee every time a consumer uses one of its cards and associated payment infrastructure.  Auto Trader has the additional bonus of being very reasonably valued, but to some extent this is for a reason – with such a large share of a stagnant UK market used car market, the growth story is a bit more challenging.

Quality

  • Business economics: as mentioned above, common with more online platforms Auto Trader is exceptionally profitable with a capital-light business model. Its operating margins and returns on capital are above 60%.
  • Track record: Auto Trader has only been listed since 2015, though has a consistent track record of growing profits and revenues since then.
  • Competitive advantage: Auto Trader has a very strong competitive advantage and is the dominant online platform for buying and selling cars. It operates in a two sided market and benefits from network effects, where retailers derive value from the number of consumers using the platform and vice versa. Auto Trader’s dominance is demonstrated by the fact that the vast majority of the audience using competitor  sites also use Auto Trader, while the vast majority of Auto Trader’s audience is unique. Consequently the benefit to retailers of using a competitor site is very limited. This useful recent investor presentation has more details on this and on Auto Trader’s strategy more generally.
  • Growth prospects: the fact that Auto Trader already has a very high market share of the fairly stagnant UK used car market is a downside. However, there are still some opportunities for growth. While the overall UK car market is not growing, there are opportunities for more elements of the search and transaction process to move online. There is also scope for additional value to be added for retailers, through providing them with the data and analytics to better choose what stock to buy and hold and facilitate B2B transactions. There is also scope for growth the the new car market, where currently online platforms do not have a very prominent role. Ultimately, Auto Trader sees the endgame as facilitating fully online transactions. The growth opportunities, while a little speculative at the moment, do seem real and Auto Trader is in pole position to take advantage of them given its current dominance in used car online search.

Price

I briefly profiled Auto Trader last week as a possible ‘buy the dip’ opportunity, so as you might imagine, current momentum is not great. The share price has stagnated for a couple of years along with the prospects of the UK car market. However, in the meantime Auto Trader’s profits have continued to grow and the valuation now looks very cheap as a result. As indicated by the ZPG transaction, valuations of UK online platforms are likely looking attractive to overseas buyers because of the weak Pound. I hope this may provide an additional short term catalyst for the share price.

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