Cambria Automobiles CAMB
January 11, 2018 - 10:39pm EST by
AlexB91
2018 2019
Price: 0.58 EPS 0.075 0.079
Shares Out. (in M): 100 P/E 7.7 7.3
Market Cap (in $M): 58 P/FCF 0 0
Net Debt (in $M): -6 EBIT 10 11
TEV ($): 52 TEV/EBIT 5 4.8

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Description

 
Cambria Automobiles is a United Kingdom based auto dealership group that was founded by
current CEO Mark Lavery in 2006 to pursue a dealership roll-up strategy. Lavery owns 40% of
the outstanding shares and from a starting capital base of only £10.8m has built Cambria into a
business with a market cap of £58m along with operating earnings of £11.8m in 2017. This
impressive performance over the past 11 years has been achieved during a period that has
included two recessions in the UK.
 
Auto dealers are high quality businesses and Cambria has averaged an ROE in the high teens. In
2017, Cambria earned an ROE of 20%. 40% of Cambria’s gross profits are generated by
aftermarket (parts and service) which is not cyclical and will benefit from multiple tailwinds over
time. Used car sales make up another 30% of gross profits and this portion of the business is
consistent and growing.
 
Cambria is trading for just 6.3 times earnings. Earnings are being depressed by two temporary
factors that I will discuss in further detail in the valuation section. Going forward, Cambria’s
business has multiple tailwinds that will benefit earnings in the long run. 1) High margin
aftermarket parts and service revenue is consistently growing. 2) Many of their acquired
dealerships have not reached their full operational potential. 3) There are six capital projects
under way that will contribute to earnings once complete. 4) Cambria’s management team has
demonstrated intelligent capital allocation decisions over time and I expect them to continue to
deploy existing cash flows into intelligent acquisitions.
 
Cambria trades at a large discount to peers in the United States and historical acquisition
multiples in the UK. In the next 5-7 years, I believe Cambria will reach £1 billion in sales and
earn a 2% pre-tax margin. If this is achieved and Cambria trades in line with US peers and
historical buyout multiples, Cambria is likely worth 4 times the current price.
 
Business
 
Cambria is comprised of 31 dealerships representing 46 franchises and 16 brands. Brands consist
of Abarth, Alfa Romeo, Aston Martin, Dacia, Ford, Fiat, Honda, Jaguar, Jeep, Land Rover,
Mazda, Nissan, Renault, Seat, Vauxhall, Volvo, Triumph, and they will soon add ultra-luxury
brands Bentley and McLaren.
 
Cambria has a unique strategy. They purchase sub-scale and underperforming dealerships and
implement extensive processes and systems to improve operations. A typical seller is an
entrepreneur that is either retiring or looking to sell out. There are over 5,000 individual auto
dealers in the UK and ownership is very fragmented, with most operators owning just one or two
dealerships. Oftentimes these dealerships are inefficiently run and sub-scale without the ability to
purchase expensive software and other processes to optimize their business. Scale matters in the
auto dealership business and Cambria has been very successful implementing a buy and build
strategy over the past 11 years.
 
Let’s examine an actual acquisition. The most recent acquisition was in July of 2016. Cambria
acquired a Jaguar and Land Rover dealership in North London from Pendragon for £2.1m. This
particular dealership was purchased at a bargain price, less than 3 times 2015 pre-tax earnings
and was earning a pre-tax margin of 1.6% at the time. This is before Cambria works to improve
both earnings and revenue by implementing their model to improve operations at this dealership.
Acquisitions such as this one create a lot of value for shareholders and I expect Lavery to deploy
ongoing cash flows to continue acquiring dealerships. After studying managements past
acquisitions, it is clear Lavery and team have demonstrated intelligent capital allocation
decisions over time.
 
I appreciate that the management team is patient and opportunistic when making acquisitions. In
fact, they have not made an acquisition in 18 months because they feel deal prices aren’t
compelling enough. Cambria’s small size, and the fragmented ownership in the UK auto
dealership market, will give them substantial opportunities to purchase underperforming dealers
when prices are more attractive.
 
Quality of the business
 
There are three components to an auto dealers business: new car sales, used car sales and
aftermarket (parts and service). A dealership is a mini monopoly for a specific brand over an
exclusive geographic area and they compete locally. For both UK and US auto dealers, ROIC is
in the high teens to 20% range. This is a good business and I don’t see anything on the horizon to
disrupt it.
 
Aftermarket
 
Let’s peel back the covers and dissect the business model. Of the three portions of an auto
dealers business, aftermarket has the best economics and is the largest contributor to earnings,
making up 40% of gross profits in a typical year. Aftermarket is also the highest margin portion
of the business with gross margins in the 40% range. Furthermore, aftermarket revenue is not
cyclical. The main driver of aftermarket parts and service revenue is the 0-5 year old car parc.
After selling a car, franchise dealers retain approximately 80% of the aftermarket business during
this period. After 5 years, the retention rate for parts and service on vehicles sold tends to decline
as consumers turn to cheaper independent mechanics.
 
I am very bullish on the aftermarket business going forward. There are a number of tailwinds to
support continued growth in aftermarket revenue.
 
1) Although automobile sales have stagnated in the UK, the 0-5 year car parc is growing and this
is a tailwind for aftermarket sales. The 0-5 year old car parc in the UK is still about 20% below
what it averaged in the mid 2000s. UK auto dealer Pendragon (which references the 0-6 year old
car parc) estimates it will continue growing through 2020.
 
2) It takes 4-5 years for a newly opened or acquired dealership to reach full potential on
aftermarket. A newly opened dealership typically doesn’t have a customer list and this take years
to develop. This is what drives aftermarket revenue.
 
3) The increasing complexity of newer cars requires expensive and sophisticated brand specific
diagnostic and repair equipment. Independent mechanics have a tough time justifying this large
investment in specific equipment for each individual brand. As a result, the barriers to entry for
independent mechanics is growing and auto manufacturers favor the franchise dealers.
Independent mechanics are being frozen out and the number of independent mechanics in the
UK is steadily falling. Going forward, I believe franchise dealers will continue to retain an
increasing share of service revenue.
 
4) Connected vehicles have the ability to connect back to the franchise dealers and notify
customers before a part goes out. This will increase retention of aftermarket revenue.
 
5) The increasing use of leases and finance contracts also contributes to higher retention of parts
and service for dealers as they require vehicles to get serviced at the dealership or the warranty is
voided.
 
6) Management has noted in recent releases that they are working on initiatives to further
improve the service retention on vehicles sold.
 
Overall, aftermarket is high margin and stable. I am bullish about this portion of the business
growing regardless of overall auto sales.
 
Used car sales
 
Used car sales are the second largest contributor to gross profits and make up about 30% of gross
profits in an average year. Used car sales are also quite resilient through the cycle. Cambria
excels at selling used cars with an industry leading ROI in their used car division.
 
New car sales
 
New car sales are the smallest contributor to gross profits and in a typical year make up slightly
less than 30% of gross profits. The market is concerned about falling new car sales in the UK
and I believe this is a major reason Cambria is undervalued. However, I will illustrate why this
should not worry a long-term investor, later in the report.
 
Cambria’s business model is resilient and is underpinned by non-cyclical aftermarket parts and
service revenue. Management not only successfully navigated two recessions in the past 11
years, they prudently took advantage of these adverse conditions to opportunistically make
acquisitions at distressed prices. Cambria has plenty of capacity to make acquisitions if the price
is attractive.
 
I believe Cambria’s business is more resilient today than it has been in the past for the following
reasons: 1) Cambria has shifted its focus from mass market brands to premium and luxury, which
are more stable during a downturn. 2) Lavery believes industry new car sales will be less volatile
going forward due to the growing popularity of personal contract purchase (PCP) contracts. In
2012, 40% of UK new car purchases were financed and today that number exceeds 80%.
 
Financing terms are generally 36 months and create a natural replacement cycle because
consumers upgrade their vehicles at the end of the term. 3) Cambria’s business is more mature
today with a greater portion of higher quality aftermarket and used car revenue.
 
Management
 
I’ve studied the track record of the management team and it is impressive. Lavery has turned a
total invested capital base of £10.8m into a business that produced £11.8m in underlying
operating earnings in 2017. Growth has been self-funded with minimal leverage. Lavery’s
incentives are aligned with shareholders, he owns 40% of the shares outstanding purchased on
his own rather than through options grants.
 
Lavery acts counter cyclically and his track record of buying dealerships and turning them
around has a demonstrated history of success. I’ve studied Lavery and Chairman Philip
Swatman’s letters to shareholders over the past 7 years and they are the type of managers I like
to invest alongside. Management’s overarching goal is to maintain a superior and consistent
return on equity. This focus is rare. They highlight this focus throughout every shareholder letter
in the annual report. For example, in their 2017 letter to shareholders they say, “For compelling
acquisition targets, like the JLR acquisitions, where a premium may need to be paid, we will still
focus on ensuring that the Group delivers strong and consistent returns on equity.”
Management’s acquisition discipline is also impressive. In the 2017 letter to shareholders Lavery
says, “We maintain a pipeline of prospects, but we will only acquire a business if we believe that
it is capable of generating a superior return against capital required and will respond to the
operational changes and discipline the team brings.” It is clear in the letters that this management
team is shareholder focused and honest in their assessments. In the 2016 shareholder letter,
Lavery mentions, “The board remains confident that Cambria’s resilient business model is well
positioned to take advantage of any opportunities that the current economic uncertainty could
provide.”
 
Tailwinds
 
Cambria will benefit from multiple positive tailwinds going forward:
 
1) Many of their acquisitions have not yet reached full operational potential. It takes 4-5 years
for an acquired dealership to fully benefit from the initiatives that management implements to
improve operations. This provides a natural earnings tailwind over time.
 
2) Further growth in aftermarket as discussed above.
 
3) There are a number of capital projects under way that will contribute to earnings once 
complete:
 
Barnet Jaguar Land Rover launched in July 2017. This is a redevelopment of an existing
site that began in February 2016 and cost £7m. Management noted there has been a
significant amount of disruption to the Barnet business while its been under construction
over the past year. It will take a number of years for this dealership to reach its full
potential.
 
The Swindon Jaguar Land Rover redevelopment commenced in May 2017 and will open
in July 2018. This will replace the existing dealership on the site. The cost of this project
is £6m.
 
Cambria is also in the process of acquiring land in the Welwyn Garden City territory to
relocate their existing Jaguar Land Rover and Aston Martin dealership in Welwyn. The
new facility will also house a new McLaren franchise. They have agreed to terms on a 4.3
acre piece of land in Hatfield. The total cost for the land and development is estimated to
be £17m. They plan to begin this project in January 2018 and complete it by the end of
2018.
 
They also secured a new development site in Solihull for an Aston Martin dealership to
replace a temporary facility that opened in May 2016. The total cost for the Solihul site is
estimated to be £5m. They plan to complete this project by the end of Q1 2019.
 
Cambria will add two Bentley franchises to existing locations. They are in the process of
refurbishing existing freehold premises at a cost of £1m. These two franchises will be
operational by January 2018.
 
These projects have been incurring costs during development and have yet to contribute to
earnings. Acquisitions in the past 3 years have marked a shift from volume brands to premium
and luxury brands. Although Cambria is paying higher multiples for premium and luxury
dealerships, they are more resilient through the cycle and have higher margins. Premium and
luxury brands warrant a higher multiple for Cambria if it is ever acquired.
 
4) Cambria’s owner operator management team has a demonstrated history of intelligent capital
allocation decisions over time. I expect ongoing cash flows will be deployed into further
acquisitions of sub-scale dealers at intelligent prices. There are over 5,000 dealerships in the UK
and ownership is fragmented with most operators owning just one or two locations. Cambria’s
strategy is scalable.
 
Valuation
 
Any way you slice it, Cambria is undervalued. Cambria trades for just 6.3 times TTM earnings.
This is despite two temporary factors negatively affecting earnings in 2017: 1) The construction
at the Barnet dealership has had a significant impact on profitability at this dealership. 2) A fire
that took place in October of 2016 at the Jaguar and Aston Martin dealership in Welwyn
significantly hurt the profitability of that site. The Barnet project was finished in July 2017 and
the Welwyn site was back in operation in June 2017.
 
Cambria trades at a large discount to peers in the US. Damodaran has US automotive retail
trading at an average EV/EBIT of 18.44 compared to 4.6 for Cambria. US peers (AN, KMX,
CPRT, KAR, GPI, LAD, PAG, SAH) trade at an average forward EV/ EBITDA of 12.8, compared
to 3.7 for Cambria. Those peers also trade for 15.4 forward earnings compared to 7.7
for Cambria. There is no reason for this discount, as the business models are the same.
 
Cambria trades at a discount to historical buyout multiples. Reg Vardy was purchased in 2005 by
Pendragon for £500m at just over 18x TTM earnings, 2.43 times book value and an EV to sales
of .28. By comparison, Cambria currently trades for 6.3 times earnings, 1.15 times book value
and an EV to sales of .08. Cambria trades at less than one third of the valuation of the Reg
Vardy acquisition. This is a good comparison to Cambria. Lavery was the operations director at
Reg Vardy at the time of its sale. Additionally, Reg Vardy’s dealerships were made up of a
similar group of brands to what Cambria has today. At the time of sale, Reg Vardy’s 2005
operating margin was 2.33% which highlights the margin improvement potential at Cambria.
 
Management’s goal is to grow the business to £1 billion in sales and earn a 2% pre-tax margin.
In 2017, sales were £644m and pre-tax margins were 1.8%. Results thus far suggest this is an
obtainable goal. I believe the revenue goal is likely to be achieved from organic growth alone. I
also believe 2% pre-tax margins are quite likely to be achieved. Many of their dealerships are not
yet at full margin potential. At Reg Vardy, the same management team achieved pre-tax margins
of 2.33%. I believe they are more likely to exceed both the revenue and margin goal within 5
years.
 
This would result in £20m in pre-tax income and £16.5m in after-tax income. If these results are
achieved, the stock is selling for less than 4 times future after-tax earnings.
 
I believe this goal is achievable. I also believe Cambria should trade more in line with US peers.
If Cambria achieves after-tax net income of £16.5m at a multiple of 15.4 times earnings (in line
with US peers), the business is worth £254m, or 4 times the current price.
 
The auto dealers are quite popular with value investors in the US. The same business model
exists in the UK at half the valuation. There is no reason for this discount to exist. Warren
Buffett purchased the largest privately held US dealership chain, the Van Tuyl Group, in 2014.
 
Balance sheet
 
Throughout Cambria’s history, management has financed the business conservatively. Cambria
has a net debt balance of just £3.4m at August 31st 2017 (including dealer floorplan financing).
In November 2017, Cambria refinanced their revolving credit facility for another 5-year term and
added an additional £23m in availability. Cambria has plenty of capital available to make
prudent acquisitions if the opportunity arises. I appreciate management’s conservative mentality.
This is a sleep well at night investment.
 
Auto dealers rely on dealer floorplan financing from their automotive partners to finance their
vehicle stock. This shows up in the payables line and I regard this as additional debt. When
evaluating the capital structure of auto dealers, I incorporate this financing and net it against the
value of the vehicle stock. Typically, dealers have significantly less in inventory than they do in
floorplan financing. Aggressive management teams use this to increase leverage and typical
metrics miss this fact.
 
When this adjustment is made, it becomes clear that Cambria is far less levered than their peers.
Cambria’s adjusted debt to equity is 7%, Pendragon is at 62% and Marshall Motor Works is at
123%. Cambria has one of the most conservative capital structures in the industry and at the
same time has the highest ROE of any dealership group in the UK. Their conservative balance
sheet will allow them to make more acquisitions in a downturn when some of their competitors
may be forced sellers.
 
Why is this cheap?
 
The market is worried about declining UK new car sales and I believe this is the reason the
sector is cheap. A long-term investor should not worry about this. In fact, in will end up
benefitting a long-term and patient investor.
 
Cambria has successfully operated through two recessions and I believe their business is even
more resilient today than it was during the prior two downturns. Cambria’s success to date is due
in large part to the acquisitions made during the past two downturns. Cambria is conservatively
financed and has ample capacity to make distressed acquisitions if the opportunity presents itself.
Long-term shareholders should do well regardless of market conditions.
 
Let’s explore what happened during the double dip recession in the UK in the back half of 2011
and first half of 2012. During this period, Cambria’s earnings fell 37%. However, they acquired
a few dealerships that were losing money at the time. When you take out the effect of those
acquired dealerships, earnings fell by 28%. New car sales made up the entire decline with both
used car sales and aftermarket remaining stable during this period. Cambria’s ROE bottomed out
at 13.5% that year. If Cambria witnesses a similar earnings decline today, it would be trading at
9.3 times earnings, a multiple I believe is still significantly undervalued for this high quality
business model.
 
Cambria’s business is becoming more resilient over time. The greater portion of revenue coming
from luxury brands provides more stability during a downturn. Going forward, management is
focused on continuing to move away from mass market brands and expanding in premium and
luxury, which will add to the consistency of earnings. Additionally, management believes the
natural replacement cycle created by the growth in financing contracts will smooth out the cycle.
Finally, as the existing dealerships mature, the portion of profits being generated by aftermarket
increases as a percent of a dealerships profits and the non-cyclical nature of this portion of the
business will lead to more consistent earnings overall. This business is less cyclical than people
think and investors are more than compensated for the risk of a downturn.
 
Disclosure:
 
This has been prepared solely for informational purposes. Information herein is not intended to
be complete, and such information is qualified in its entirety. This is not an offering or the
solicitation of an offer to purchase an interest in any fund, and it is not an offer to buy or sell or a
solicitation of an offer to buy or sell any security. Nothing herein should be construed as
investment advice, an opinion regarding the appropriateness or suitability of any investment, on
an investment recommendation. No representation is made that the objectives or goals of any
investment or strategy will be met or that an investment or strategy will be profitable or will not
incur losses. Past performance is no guarantee of future results. Reliable methods were used to
obtain information for this presentation but the information herein cannot be guaranteed for
accuracy or reliability; the information in this presentation may be out of date or inaccurate. The
information contained in this summary is and may not be distributed without permission.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1) Valuation converges with historical multiples and peers in the US. 2) Many of their dealerships have not reached their full operational potential providing latent growth in earnings. 3) The six capital projects underway have yet to contribute to earnings and will be complete within the next few years. 4) Continued investment of excess cash flows at high returns. 5) Eventual sale to a larger dealership group. 

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    Description

     
    Cambria Automobiles is a United Kingdom based auto dealership group that was founded by
    current CEO Mark Lavery in 2006 to pursue a dealership roll-up strategy. Lavery owns 40% of
    the outstanding shares and from a starting capital base of only £10.8m has built Cambria into a
    business with a market cap of £58m along with operating earnings of £11.8m in 2017. This
    impressive performance over the past 11 years has been achieved during a period that has
    included two recessions in the UK.
     
    Auto dealers are high quality businesses and Cambria has averaged an ROE in the high teens. In
    2017, Cambria earned an ROE of 20%. 40% of Cambria’s gross profits are generated by
    aftermarket (parts and service) which is not cyclical and will benefit from multiple tailwinds over
    time. Used car sales make up another 30% of gross profits and this portion of the business is
    consistent and growing.
     
    Cambria is trading for just 6.3 times earnings. Earnings are being depressed by two temporary
    factors that I will discuss in further detail in the valuation section. Going forward, Cambria’s
    business has multiple tailwinds that will benefit earnings in the long run. 1) High margin
    aftermarket parts and service revenue is consistently growing. 2) Many of their acquired
    dealerships have not reached their full operational potential. 3) There are six capital projects
    under way that will contribute to earnings once complete. 4) Cambria’s management team has
    demonstrated intelligent capital allocation decisions over time and I expect them to continue to
    deploy existing cash flows into intelligent acquisitions.
     
    Cambria trades at a large discount to peers in the United States and historical acquisition
    multiples in the UK. In the next 5-7 years, I believe Cambria will reach £1 billion in sales and
    earn a 2% pre-tax margin. If this is achieved and Cambria trades in line with US peers and
    historical buyout multiples, Cambria is likely worth 4 times the current price.
     
    Business
     
    Cambria is comprised of 31 dealerships representing 46 franchises and 16 brands. Brands consist
    of Abarth, Alfa Romeo, Aston Martin, Dacia, Ford, Fiat, Honda, Jaguar, Jeep, Land Rover,
    Mazda, Nissan, Renault, Seat, Vauxhall, Volvo, Triumph, and they will soon add ultra-luxury
    brands Bentley and McLaren.
     
    Cambria has a unique strategy. They purchase sub-scale and underperforming dealerships and
    implement extensive processes and systems to improve operations. A typical seller is an
    entrepreneur that is either retiring or looking to sell out. There are over 5,000 individual auto
    dealers in the UK and ownership is very fragmented, with most operators owning just one or two
    dealerships. Oftentimes these dealerships are inefficiently run and sub-scale without the ability to
    purchase expensive software and other processes to optimize their business. Scale matters in the
    auto dealership business and Cambria has been very successful implementing a buy and build
    strategy over the past 11 years.
     
    Let’s examine an actual acquisition. The most recent acquisition was in July of 2016. Cambria
    acquired a Jaguar and Land Rover dealership in North London from Pendragon for £2.1m. This
    particular dealership was purchased at a bargain price, less than 3 times 2015 pre-tax earnings
    and was earning a pre-tax margin of 1.6% at the time. This is before Cambria works to improve
    both earnings and revenue by implementing their model to improve operations at this dealership.
    Acquisitions such as this one create a lot of value for shareholders and I expect Lavery to deploy
    ongoing cash flows to continue acquiring dealerships. After studying managements past
    acquisitions, it is clear Lavery and team have demonstrated intelligent capital allocation
    decisions over time.
     
    I appreciate that the management team is patient and opportunistic when making acquisitions. In
    fact, they have not made an acquisition in 18 months because they feel deal prices aren’t
    compelling enough. Cambria’s small size, and the fragmented ownership in the UK auto
    dealership market, will give them substantial opportunities to purchase underperforming dealers
    when prices are more attractive.
     
    Quality of the business
     
    There are three components to an auto dealers business: new car sales, used car sales and
    aftermarket (parts and service). A dealership is a mini monopoly for a specific brand over an
    exclusive geographic area and they compete locally. For both UK and US auto dealers, ROIC is
    in the high teens to 20% range. This is a good business and I don’t see anything on the horizon to
    disrupt it.
     
    Aftermarket
     
    Let’s peel back the covers and dissect the business model. Of the three portions of an auto
    dealers business, aftermarket has the best economics and is the largest contributor to earnings,
    making up 40% of gross profits in a typical year. Aftermarket is also the highest margin portion
    of the business with gross margins in the 40% range. Furthermore, aftermarket revenue is not
    cyclical. The main driver of aftermarket parts and service revenue is the 0-5 year old car parc.
    After selling a car, franchise dealers retain approximately 80% of the aftermarket business during
    this period. After 5 years, the retention rate for parts and service on vehicles sold tends to decline
    as consumers turn to cheaper independent mechanics.
     
    I am very bullish on the aftermarket business going forward. There are a number of tailwinds to
    support continued growth in aftermarket revenue.
     
    1) Although automobile sales have stagnated in the UK, the 0-5 year car parc is growing and this
    is a tailwind for aftermarket sales. The 0-5 year old car parc in the UK is still about 20% below
    what it averaged in the mid 2000s. UK auto dealer Pendragon (which references the 0-6 year old
    car parc) estimates it will continue growing through 2020.
     
    2) It takes 4-5 years for a newly opened or acquired dealership to reach full potential on
    aftermarket. A newly opened dealership typically doesn’t have a customer list and this take years
    to develop. This is what drives aftermarket revenue.
     
    3) The increasing complexity of newer cars requires expensive and sophisticated brand specific
    diagnostic and repair equipment. Independent mechanics have a tough time justifying this large
    investment in specific equipment for each individual brand. As a result, the barriers to entry for
    independent mechanics is growing and auto manufacturers favor the franchise dealers.
    Independent mechanics are being frozen out and the number of independent mechanics in the
    UK is steadily falling. Going forward, I believe franchise dealers will continue to retain an
    increasing share of service revenue.
     
    4) Connected vehicles have the ability to connect back to the franchise dealers and notify
    customers before a part goes out. This will increase retention of aftermarket revenue.
     
    5) The increasing use of leases and finance contracts also contributes to higher retention of parts
    and service for dealers as they require vehicles to get serviced at the dealership or the warranty is
    voided.
     
    6) Management has noted in recent releases that they are working on initiatives to further
    improve the service retention on vehicles sold.
     
    Overall, aftermarket is high margin and stable. I am bullish about this portion of the business
    growing regardless of overall auto sales.
     
    Used car sales
     
    Used car sales are the second largest contributor to gross profits and make up about 30% of gross
    profits in an average year. Used car sales are also quite resilient through the cycle. Cambria
    excels at selling used cars with an industry leading ROI in their used car division.
     
    New car sales
     
    New car sales are the smallest contributor to gross profits and in a typical year make up slightly
    less than 30% of gross profits. The market is concerned about falling new car sales in the UK
    and I believe this is a major reason Cambria is undervalued. However, I will illustrate why this
    should not worry a long-term investor, later in the report.
     
    Cambria’s business model is resilient and is underpinned by non-cyclical aftermarket parts and
    service revenue. Management not only successfully navigated two recessions in the past 11
    years, they prudently took advantage of these adverse conditions to opportunistically make
    acquisitions at distressed prices. Cambria has plenty of capacity to make acquisitions if the price
    is attractive.
     
    I believe Cambria’s business is more resilient today than it has been in the past for the following
    reasons: 1) Cambria has shifted its focus from mass market brands to premium and luxury, which
    are more stable during a downturn. 2) Lavery believes industry new car sales will be less volatile
    going forward due to the growing popularity of personal contract purchase (PCP) contracts. In
    2012, 40% of UK new car purchases were financed and today that number exceeds 80%.
     
    Financing terms are generally 36 months and create a natural replacement cycle because
    consumers upgrade their vehicles at the end of the term. 3) Cambria’s business is more mature
    today with a greater portion of higher quality aftermarket and used car revenue.
     
    Management
     
    I’ve studied the track record of the management team and it is impressive. Lavery has turned a
    total invested capital base of £10.8m into a business that produced £11.8m in underlying
    operating earnings in 2017. Growth has been self-funded with minimal leverage. Lavery’s
    incentives are aligned with shareholders, he owns 40% of the shares outstanding purchased on
    his own rather than through options grants.
     
    Lavery acts counter cyclically and his track record of buying dealerships and turning them
    around has a demonstrated history of success. I’ve studied Lavery and Chairman Philip
    Swatman’s letters to shareholders over the past 7 years and they are the type of managers I like
    to invest alongside. Management’s overarching goal is to maintain a superior and consistent
    return on equity. This focus is rare. They highlight this focus throughout every shareholder letter
    in the annual report. For example, in their 2017 letter to shareholders they say, “For compelling
    acquisition targets, like the JLR acquisitions, where a premium may need to be paid, we will still
    focus on ensuring that the Group delivers strong and consistent returns on equity.”
    Management’s acquisition discipline is also impressive. In the 2017 letter to shareholders Lavery
    says, “We maintain a pipeline of prospects, but we will only acquire a business if we believe that
    it is capable of generating a superior return against capital required and will respond to the
    operational changes and discipline the team brings.” It is clear in the letters that this management
    team is shareholder focused and honest in their assessments. In the 2016 shareholder letter,
    Lavery mentions, “The board remains confident that Cambria’s resilient business model is well
    positioned to take advantage of any opportunities that the current economic uncertainty could
    provide.”
     
    Tailwinds
     
    Cambria will benefit from multiple positive tailwinds going forward:
     
    1) Many of their acquisitions have not yet reached full operational potential. It takes 4-5 years
    for an acquired dealership to fully benefit from the initiatives that management implements to
    improve operations. This provides a natural earnings tailwind over time.
     
    2) Further growth in aftermarket as discussed above.
     
    3) There are a number of capital projects under way that will contribute to earnings once 
    complete:
     
    Barnet Jaguar Land Rover launched in July 2017. This is a redevelopment of an existing
    site that began in February 2016 and cost £7m. Management noted there has been a
    significant amount of disruption to the Barnet business while its been under construction
    over the past year. It will take a number of years for this dealership to reach its full
    potential.
     
    The Swindon Jaguar Land Rover redevelopment commenced in May 2017 and will open
    in July 2018. This will replace the existing dealership on the site. The cost of this project
    is £6m.
     
    Cambria is also in the process of acquiring land in the Welwyn Garden City territory to
    relocate their existing Jaguar Land Rover and Aston Martin dealership in Welwyn. The
    new facility will also house a new McLaren franchise. They have agreed to terms on a 4.3
    acre piece of land in Hatfield. The total cost for the land and development is estimated to
    be £17m. They plan to begin this project in January 2018 and complete it by the end of
    2018.
     
    They also secured a new development site in Solihull for an Aston Martin dealership to
    replace a temporary facility that opened in May 2016. The total cost for the Solihul site is
    estimated to be £5m. They plan to complete this project by the end of Q1 2019.
     
    Cambria will add two Bentley franchises to existing locations. They are in the process of
    refurbishing existing freehold premises at a cost of £1m. These two franchises will be
    operational by January 2018.
     
    These projects have been incurring costs during development and have yet to contribute to
    earnings. Acquisitions in the past 3 years have marked a shift from volume brands to premium
    and luxury brands. Although Cambria is paying higher multiples for premium and luxury
    dealerships, they are more resilient through the cycle and have higher margins. Premium and
    luxury brands warrant a higher multiple for Cambria if it is ever acquired.
     
    4) Cambria’s owner operator management team has a demonstrated history of intelligent capital
    allocation decisions over time. I expect ongoing cash flows will be deployed into further
    acquisitions of sub-scale dealers at intelligent prices. There are over 5,000 dealerships in the UK
    and ownership is fragmented with most operators owning just one or two locations. Cambria’s
    strategy is scalable.
     
    Valuation
     
    Any way you slice it, Cambria is undervalued. Cambria trades for just 6.3 times TTM earnings.
    This is despite two temporary factors negatively affecting earnings in 2017: 1) The construction
    at the Barnet dealership has had a significant impact on profitability at this dealership. 2) A fire
    that took place in October of 2016 at the Jaguar and Aston Martin dealership in Welwyn
    significantly hurt the profitability of that site. The Barnet project was finished in July 2017 and
    the Welwyn site was back in operation in June 2017.
     
    Cambria trades at a large discount to peers in the US. Damodaran has US automotive retail
    trading at an average EV/EBIT of 18.44 compared to 4.6 for Cambria. US peers (AN, KMX,
    CPRT, KAR, GPI, LAD, PAG, SAH) trade at an average forward EV/ EBITDA of 12.8, compared
    to 3.7 for Cambria. Those peers also trade for 15.4 forward earnings compared to 7.7
    for Cambria. There is no reason for this discount, as the business models are the same.
     
    Cambria trades at a discount to historical buyout multiples. Reg Vardy was purchased in 2005 by
    Pendragon for £500m at just over 18x TTM earnings, 2.43 times book value and an EV to sales
    of .28. By comparison, Cambria currently trades for 6.3 times earnings, 1.15 times book value
    and an EV to sales of .08. Cambria trades at less than one third of the valuation of the Reg
    Vardy acquisition. This is a good comparison to Cambria. Lavery was the operations director at
    Reg Vardy at the time of its sale. Additionally, Reg Vardy’s dealerships were made up of a
    similar group of brands to what Cambria has today. At the time of sale, Reg Vardy’s 2005
    operating margin was 2.33% which highlights the margin improvement potential at Cambria.
     
    Management’s goal is to grow the business to £1 billion in sales and earn a 2% pre-tax margin.
    In 2017, sales were £644m and pre-tax margins were 1.8%. Results thus far suggest this is an
    obtainable goal. I believe the revenue goal is likely to be achieved from organic growth alone. I
    also believe 2% pre-tax margins are quite likely to be achieved. Many of their dealerships are not
    yet at full margin potential. At Reg Vardy, the same management team achieved pre-tax margins
    of 2.33%. I believe they are more likely to exceed both the revenue and margin goal within 5
    years.
     
    This would result in £20m in pre-tax income and £16.5m in after-tax income. If these results are
    achieved, the stock is selling for less than 4 times future after-tax earnings.
     
    I believe this goal is achievable. I also believe Cambria should trade more in line with US peers.
    If Cambria achieves after-tax net income of £16.5m at a multiple of 15.4 times earnings (in line
    with US peers), the business is worth £254m, or 4 times the current price.
     
    The auto dealers are quite popular with value investors in the US. The same business model
    exists in the UK at half the valuation. There is no reason for this discount to exist. Warren
    Buffett purchased the largest privately held US dealership chain, the Van Tuyl Group, in 2014.
     
    Balance sheet
     
    Throughout Cambria’s history, management has financed the business conservatively. Cambria
    has a net debt balance of just £3.4m at August 31st 2017 (including dealer floorplan financing).
    In November 2017, Cambria refinanced their revolving credit facility for another 5-year term and
    added an additional £23m in availability. Cambria has plenty of capital available to make
    prudent acquisitions if the opportunity arises. I appreciate management’s conservative mentality.
    This is a sleep well at night investment.
     
    Auto dealers rely on dealer floorplan financing from their automotive partners to finance their
    vehicle stock. This shows up in the payables line and I regard this as additional debt. When
    evaluating the capital structure of auto dealers, I incorporate this financing and net it against the
    value of the vehicle stock. Typically, dealers have significantly less in inventory than they do in
    floorplan financing. Aggressive management teams use this to increase leverage and typical
    metrics miss this fact.
     
    When this adjustment is made, it becomes clear that Cambria is far less levered than their peers.
    Cambria’s adjusted debt to equity is 7%, Pendragon is at 62% and Marshall Motor Works is at
    123%. Cambria has one of the most conservative capital structures in the industry and at the
    same time has the highest ROE of any dealership group in the UK. Their conservative balance
    sheet will allow them to make more acquisitions in a downturn when some of their competitors
    may be forced sellers.
     
    Why is this cheap?
     
    The market is worried about declining UK new car sales and I believe this is the reason the
    sector is cheap. A long-term investor should not worry about this. In fact, in will end up
    benefitting a long-term and patient investor.
     
    Cambria has successfully operated through two recessions and I believe their business is even
    more resilient today than it was during the prior two downturns. Cambria’s success to date is due
    in large part to the acquisitions made during the past two downturns. Cambria is conservatively
    financed and has ample capacity to make distressed acquisitions if the opportunity presents itself.
    Long-term shareholders should do well regardless of market conditions.
     
    Let’s explore what happened during the double dip recession in the UK in the back half of 2011
    and first half of 2012. During this period, Cambria’s earnings fell 37%. However, they acquired
    a few dealerships that were losing money at the time. When you take out the effect of those
    acquired dealerships, earnings fell by 28%. New car sales made up the entire decline with both
    used car sales and aftermarket remaining stable during this period. Cambria’s ROE bottomed out
    at 13.5% that year. If Cambria witnesses a similar earnings decline today, it would be trading at
    9.3 times earnings, a multiple I believe is still significantly undervalued for this high quality
    business model.
     
    Cambria’s business is becoming more resilient over time. The greater portion of revenue coming
    from luxury brands provides more stability during a downturn. Going forward, management is
    focused on continuing to move away from mass market brands and expanding in premium and
    luxury, which will add to the consistency of earnings. Additionally, management believes the
    natural replacement cycle created by the growth in financing contracts will smooth out the cycle.
    Finally, as the existing dealerships mature, the portion of profits being generated by aftermarket
    increases as a percent of a dealerships profits and the non-cyclical nature of this portion of the
    business will lead to more consistent earnings overall. This business is less cyclical than people
    think and investors are more than compensated for the risk of a downturn.
     
    Disclosure:
     
    This has been prepared solely for informational purposes. Information herein is not intended to
    be complete, and such information is qualified in its entirety. This is not an offering or the
    solicitation of an offer to purchase an interest in any fund, and it is not an offer to buy or sell or a
    solicitation of an offer to buy or sell any security. Nothing herein should be construed as
    investment advice, an opinion regarding the appropriateness or suitability of any investment, on
    an investment recommendation. No representation is made that the objectives or goals of any
    investment or strategy will be met or that an investment or strategy will be profitable or will not
    incur losses. Past performance is no guarantee of future results. Reliable methods were used to
    obtain information for this presentation but the information herein cannot be guaranteed for
    accuracy or reliability; the information in this presentation may be out of date or inaccurate. The
    information contained in this summary is and may not be distributed without permission.
    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    1) Valuation converges with historical multiples and peers in the US. 2) Many of their dealerships have not reached their full operational potential providing latent growth in earnings. 3) The six capital projects underway have yet to contribute to earnings and will be complete within the next few years. 4) Continued investment of excess cash flows at high returns. 5) Eventual sale to a larger dealership group. 

    Messages


    SubjectQuestions
    Entry01/14/2018 04:17 AM
    MemberBarong

    1. Is there a risk that EVs require less costly services than fossil fueled cars because of fewer moving engine parts etc? ( I live in a countrywith very high EV penetration (Norway) and I realize that this is not the case to the same degree in the UK; but the trend is towards more EVs everywhere over time). Would be interested to hear your thoughts on this. It looks like service revenue is more than 10 percent lower judging from this BILIA SS CMD presentation for example.

    http://www.bilia.com/EPiUpload/COM/Kapitalmarknadsdag/Capital%20Markets%20Day%20171110_NY.pdf

    (slide 131).

    2. Your comp set consists at least partly of some very large companies. Given the small size and limited liquidity, is a multiple in line with this average really appropriate (I realize it still looks cheap even adjusting for this), especially given the limited growth opportunity currently (you state that prices are high in the space at the moment)?


    SubjectRe: Questions
    Entry01/14/2018 05:49 AM
    Memberrhubarb

    I have a couple as well.

    They have committed to spend half their market cap on capex.  This seems like a deviation from the original strategy where they focused on acquiring underperforming dealerships and implemented better operating practices.  Is this prudent?  On of my concerns with new car dealers in U.K. is the OEMs are always pressuring dealers to build extravagant showrooms.  It seems like Cambria has taken the bait here.  Do you share this concern?  What type of returns do you expect from this spend?

    The market appears to be saying that U.K. new car sales are above midcycle and that these companies are overearning.  Looking at U.K. car sales data, this seems to be a reasonable assumption.  I understand that the service side is less cyclical, but they do make plenty of gross profit selling cars (new and used) as well.  Do you have a view on what midcycle SAAR is and what Cambria would earn on midcycle volune with today’s footprint?

    Insiders are sending mixed messages.  The chairman just sold 100k shares a week ago at these levels.  Do you know the story there?

     


    SubjectCompelling valuation
    Entry01/14/2018 02:09 PM
    Memberdutchballa

    The thesis and valuation you point out looks extremely compelling especially with the pent up earnings you claim are there from the capex projects and the businesses sound the same as the US dealers as you point out.

    Is there a reason that Lavery and the board don't just take out the remainder of the float which would be a mere $30m check and keep the 4x upside you claim for themselves? Why would anyone with good information sell any stock at these levels and not be hoovering in as much as possible? There is no leverage to boot. It's very perplexing. Have you spoken to management about this or have any theories of your own? 


    SubjectRe: Compelling valuation
    Entry01/15/2018 12:36 PM
    MemberAlexB91
    Barong, Rhubard and Dutchballa,
     
    Thanks for the questions. I have limited time today, but I will address the question on the insider sale. I will make sure to get to the other questions soon. 
     
    You referenced the sale of 100,000 shares by chairman Philip Swatman on the 4th of January. In the filling it noted that he sold the shares to partially finance a house purchase and he has no plans to sell any more shares. Since this happened just a few weeks ago, I know nothing more than what was included in the filling. I'm hoping this is nothing more than just noise, but I will bring it up when I speak to management to hear what they have to say. Here is the filling: http://www.cambriaautomobilesplc.com/resources/040118DirectorDealingPS4.pdf
     
    Besides this transaction, there was a share sale in 2014 by director Sir Peter Burt (who has since passed away). The filling also referenced the shares were sold to build a new house. Besides these two transactions, all insider transactions since the company was originally listed have been purchases. 
     
    As I mentioned in my write-up, CEO Mark Lavery owns 40% of the outstanding shares and has never sold a single share.

    SubjectElectric Vehicles
    Entry01/18/2018 12:55 PM
    MemberAlexB91
    Pure EV's do require less service and maintenance. Thanks for including the presentation from Bilia which shows service and maintenance revenue is 12% lower on the BMW i3 vs. the BMW 3 series. This shows a slightly higher number and includes data for some other vehicles as well: https://www.goultralow.com/choosing/electric-car-service-and-maintenance/
     
    Electric cars will take a while to become a meaningful portion of new car sales. The speed of adoption is tough to predict but Bloomberg is forecasting that a decade from today a little more than 10% of new car sales will be pure EVs. There are many limiting factors to quick adoption of pure EVs. For example, the UK electrical grid is at 98% of capacity. The adoption of pure EVs will be gradual. 
     
     
    According to the same article, it will take until the mid-2020's for pure EVs to be cost competitive with the combustion engine: “By the mid-2020s I expect there to be a tipping point where the electric car starts to out compete the internal combustion engine. It’s the way it’s going.”
     
    The driver of aftermarket revenue is the car parc rather than new car sales. If 10-20% of new car sales are pure EVs in 2025, that would result in a very small impact to the car parc. Only 1-2% of the car parc would shift to pure EVs every year. The point being, it takes a very long time for the car parc to change. In 2025, Bloomberg forecasts that only 2% of the car parc will be pure EVs. Even in 2035, it's 19%. Assuming these numbers are roughly right, the impact on aftermarket revenue would equal: the decrease in service revenue per vehicle (I'm using 30%) multiplied by percent of pure EVs in the car parc. In 2025, this will impact aftermarket revenue by (2% *.3) = .6% and in 2035 it will be (19% *.3) = 6%. Aftermarket is 40% of Cambria's gross margin. I should point out, the 0-6 year car parc matters much more than the total car parc for a dealer's aftermarket business (as discussed in my write-up). Since the average age of an automobile in the UK is about 7 years, the 0-6 year car parc will change about twice as fast the overall car parc. 
     
    The total number of cars on the road is growing at the same time. In 2040, Bloomberg estimates that 54% of new cars sold will be pure EVs and 33% of the car parc will be pure EVs. Obviously an estimate this far out has limited value but it helps illustrate my point that overall growth in car sales will offset some or all of this headwind. The number of vehicles on the road is growing significantly over this time and even though pure EVs take a significant amount of market share over this period, the number of cars with combustion engines is growing from 1 billion to 1.2 billion. 
     
    The assumptions related to adoption of EVs are obviously subject to a wide range of outcomes. But the point is clear, adoption of pure EVs is going to take a while and the car parc is very very slow to change. The car parc changes so slowly that it will be decades before this will have a meaningful impact on aftermarket. At the same time, the number of cars on the road keeps growing, offsetting some of this headwind. Also, in my write-up I discussed some of the tailwinds that will benefit the aftermarket side of the business. One in particular is the increasing complexity of newer cars loaded with lots of new technology. The more technology in the car, the more that can go wrong and require service. The advanced technology requires expensive diagnostic and repair equipment and this makes it tougher for the independent mechanics to compete with franchise dealers for aftermarket revenue. The barriers to entry for the independent mechanics are growing. Independent mechanics will continue to close as a result and franchise dealers will gain market share in service and maintenance. The aftermarket side of Cambria's business is growing and I believe that will continue to be the case for decades before the affect of EVs begin to impact results. I will earn my purchase price back in cash flow many times over before this is a factor. 
     
    I want to end this answer by acknowledging that although I'm quite confident in the conclusion above. If anyone with more expertise in this area feels that any of my assumptions may be off or thinks I could be wrong, I would welcome counter arguments. What could cause my conclusion on this question to be incorrect would be: the adoption of EVs comes much faster than people expect or as EV technology advances, the amount of service ends up being drastically lower in pure EVs vs a conventional car. Again, I welcome thoughts from those who have expertise in this area.

    SubjectRe: Cambria vs. Peers
    Entry06/20/2018 05:43 PM
    MemberAlexB91
    Honeycreek,
     
    Thanks for the question. 
     
    As you point out, the entire UK auto dealership sector trades at a low multiple. From discussions I've had, it seems that fears related to both the recent decline in UK auto sales as well as Brexit are contributing factors to why the sector has traded down to these multiples. I view these as short term factors and since I plan to own Cambria for 5+ years I don't worry about either. 
     
    I researched all of the public UK auto dealership groups and I like Cambria the best because of the quality and track record of management, and the conservative balance sheet. I also like their focus on luxury franchises going forward.
     
    None of Cambria's peers come close to matching their track record. From a starting capital base of only £10.8m in 2006, Lavery has built Cambria into a business with a market cap of £62m (which I believe far understates intrinsic value). Cambria has achieved the highest ROE among peers over this period and at the same time has maintained the most conservative balance sheet. 
     
    I think some of the other auto dealership groups in the UK are also compelling.  I like Vertu and own it as well. Vertu's stock is much more liquid than Cambria and larger funds who are unable to buy a meaningful amount of Cambria could take a look at them. 
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