Description

Motorpoint is the largest independent used car retailer in the UK. The company is focused on selling nearly new (<15,000 miles) cars at transparent prices out of 12 locations in the UK. Motorpoint had its IPO in May of 2016 at 200p and the stock sold down to 120.50p on Brexit fears and related commentary in the 1H update. Though the stock has rebounded to 165p, I still see lots of upside and a fair value of 250p. A small float, minimal coverage, lack of public history, and misguided comparisons to franchised dealers have all contributed to the mispricing.

Summary Valuation & Thesis

At today’s price of 165p, Motorpoint trades at 11x FY’16 and 13x FY’17E EPS. The first half of FY’17 saw temporarily low margins (7% gross vs. 7.7% in 1H,’16) as management acted too aggressively towards Brexit fears by lowering prices to reduce inventory. Gross margins have since been restored. FY’17 earnings also includes >£2mm of spending on marketing and other opening costs for new locations that are one-time in nature.

If you assume developing locations reach full maturity, Motorpoint would earn 22p at current margins and 19p at a 15 year average of gross margins.  Motorpoint has returns on capital >100% and management believes they can double in size in the UK before pursuing growth in Continental Europe. Insiders own over 40% of the stock (including the CEO at >8%) and have a soft lockup from the IPO of 3 years. I think Motorpoint is worth at least 15x normal earnings of 19p a few years out, or 250p today, because of the growth runway at high incremental returns, aligned insiders, and  sustainable competitive advantages (more on those below).

Competitive Advantages

I know people looking at Motorpoint will want to slap a franchised dealer multiple on it, so I’ll address the differences between these business models first. Motorpoint’s business model is far superior to the franchised dealers for two main reasons.

1) PP&E: The OEMs require dealers to build massive and costly showrooms with cars parked in them for many months at a time. Locations are closer to city centers and thus more expensive and undersized. The showroom, body shop and fancy café also take up room. The OEMs control who can buy a franchise up for sale, and this happens frequently when an existing franchisee isn’t willing to spend what an OEM dictates (but the next guy is willing to).

2) Supply: OEMs sell to franchised dealers at a 15% discount to MSRP. Compare this to the short term rental players (Avis, Enterprise, etc.) who are buying in size every month and can go to the OEMs offering the best deals at the moment. Newer cars might be sold at 20-30% discounts to these fleet buyers, and cars at the end of their lifecycle (i.e. the production line is going to be closed or re-tooled) see discounts of 50-60%. Motorpoint is eventually buying these vehicles from the rental players and consequently is able to offer consumers a better value - slightly used but far cheaper cars. Management gave an example where the Ford Focus is end-of-life and is roughly £20k retail but Motorpoint has 6 month old product with 6-8 thousand miles selling for £9,500!

Motorpoint competes against a fragmented used car industry comprised of mostly mom & pop players. Motorpoint was just over 4% of the 1mm “nearly new” cars sold in 2015 in the UK (total used car transaction volume is ~7mm cars). New car/franchised dealers aren’t incentivized to sell nearly new cars because nearly new cars offer a terrible comp to the new cars on their lots. Below are the key components of Motorpoint’s business model.

Stock Turns:

Stock turns of >10x are twice the industry average. Cars move quickly because of aggressive pricing and a wide selection. MOTR manages the business on a one-stock basis (99 pounds to access a car from any site). About 25% of cars sold were transferred from another site. Motorpoint offers over 6,000 cars in stock at any time, which is a huge competitive advantage over mom & pop competitors.

Fast turns are achieved for two reasons:

1) MOTR prepares cars to sell more quickly than most. Speed in assessing damage is also critical because there is a narrow recharge window where certain costs can be charged back to a supplier.

2) MOTR is the only used car dealer in the UK that allows you to call up the call center, write an email, or have a live chat where you can arrange for the car, get financing, etc. and show up to a site and drive away. Motorpoint sells one in three cars this way. MOTR does charge a £300 reservation deposit that is refunded when the transaction is completed or if the buyer isn’t satisfied with the car.

Stock financing:

Used car dealerships are capital intensive businesses to start and scale. Lloyd’s provides the stock financing for Motorpoint, but Lloyd’s won’t lend to startups. Many used car dealerships start and fail every year.

Metal Margins:

Metal margin is the margin from selling the car (without financing or other add-ons) less the cost to buy and clean up the car. Motorpoint has scale with fleet sellers which more than offsets aggressive pricing. In addition to having a shorter recharge window (the time it takes to prepare a car for sale) than competitors, Motorpoint is also able to refurbish cars more cost efficiently.

Trade-ins:

Almost every car Motorpoint gets through a trade-in has to be sold wholesale out because the car has more than 15,000 miles. Motorpoint has an online wholesale business where it sells these cars to other dealers. BCA, a big auction house in the U.K., creates a price umbrella through the high fees they charge to buyers. MOTR charges low fees and benefits from the fact that they sell wholesale cars online and have the customer pick up the car from the lot. The wholesale business is a £6mm gross profit business (120mm revenue).

Other margins:

Motorpoint profits from financing commissions and other ancillary income like paint protection and extended guarantees. These sources of income have all expanded with scale as MOTR gained negotiating leverage. Other margin now accounts for half of the total margin of a retail car. 75% of retail cars are financed in some way, and Motorpoint gets a commission on 30% of those cars. Note that Motorpoint does not keep any of these loans.

Sourcing:

The UK is the second largest car market in Europe. Britons love their cars and the cars are generally much higher spec than cars in Continental Europe. Manufacturers see the UK as a profitable outlet, which helps the eventual supply of used vehicles. Of 2.5mm new cars sold each year in the U.K., about half end up in fleets, 3 year contracts for big organizations, and short term rental. Motorpoint buys from all of these sources. In 2015, 34 rental and fleet operators were 58% of Motorpoint’s total supply. Auctions were 14%.

Only half of the demand for new cars comes from retail, so if retail demand falls, the number of new cars supplied to the UK doesn’t drop as severely. More just end up in the fleet channel.

The spread between new and used cars doesn’t change much in bad times. There is heavy external (government) pressure to maintain OEM production capacity. OEM’s don’t like reducing the list price on cars because it creates problems for the residual values they assume.

Once new cars are sold into the UK they become somewhat stranded because of geography and configuration (right hand side steering wheel) which helps keep up a steady supply of used vehicles.

Above I’ve listed competitive advantages that come mostly from scale. Though new car dealers aren’t incentivized to compete, anyone else with enough capital could. But I like Motorpoint’s head start. This is a business where reputation and brand matter.

There are ways to quantify the power of the brand. Motorpoint’s Net Promoter Score of 75% is very high. Prices and financing costs are transparent and salespeople get flat commissions. If a customer deposits money and doesn’t like the car, the deposit is refunded. Motorpoint is the CarMax of the UK:  people know the brand and know that they aren’t going to get ripped off.

Almost half of Motorpoint’s website visitors are “repeat and recommend.” More than 40% of cars sold are ordered unseen. Management says the majority of customers ordering a car unseen don’t even test drive the car before driving off the lot with it. Volume driven by brand is something that cannot be created overnight. High volume accounts for the bulk of Motorpoint’s superior returns and I think this advantage is sustainable.

Valuation

I value Motorpoint primarily by considering the normal earnings power of the existing locations. I get to normal earnings power of 19p by making assumptions about the ramp of developing sites and applying historical average margins to the result.

FY 2016 retail volume per location is disclosed. I’ve compared FY 2016 volume for each developing location to the age of the location and the volume I expect at maturity to get a sense for how the ramp is progressing. I’ve estimated mature volumes by comparing the size, car capacity, and geography of developing locations to the fully mature locations.

New locations take five years to ramp and they lose money in year one and break even in year two. MOTR opened its 10th site in Castleford in April ’16 and its 11th site in Oldbury in July ’16. Motorpoint recently opened a site in Sheffield, but it’s not included in my model yet.

I expect developing locations (Chingford, Birmingham, Widnes, Birtley, Castleford, Oldbury) to retail 36k cars/year at maturity vs. 16k in FY 2016. Note that Castleford and Oldbury contributed nothing to the FY’16 number (vs. 6.6k and 5.8k estimated at maturity). The others ramp as follows:

Chingford: from 5.4k to 5.4k (I’m assuming flat)

Birmingham: from 4.9 to 6.6k

Widnes: from 4.5 to 5.2k

Birtley: from 1.2k to 6.5k

Applying a 7% gross margin (7% is a 15 year average and compares to 7.1%, 7.6% and 7.4% in FY15, FY16, and FY17E) companywide gives £70.7mm of gross profit (vs. £55.7mm in FY’16) at mature volumes. Note that I’m not growing developed locations at all in this analysis. Ramping variable costs as stores mature (salaries, commissions, etc.) gives EBITDA of £26.1mm (vs. £19.6mm in FY’16) and EPS of 19p. Most of the ramp will be achieved by FY 2019. I won’t get into the weeds with my DCF, but ramping to 19p over 4 years and applying 15x to the terminal year gets me ~250p per share today.

Risks

Locations don’t mature as expected.

High returns are competed away.

Catalyst

developing locations maturing