Description

Quick Summary

Vertu Motors PLC (VTU LN) is a UK auto dealer that is undervalued due concerns about weak current UK new car demand with 2012 sales (down 1% from 2011) expected to be the worst year in the UK since 1995.   Furthermore, sell-side analysts consider VTU to be fairly-valued at ~8-10x 2012 EPS since it trades in line with UK peers LOOK and PDG.  However, this analysis fails to understand that VTU margins have been depressed by VTU's acquisitions of loss-making dealerships.  As these acquisitions mature, VTU should be able to improve its profitability closer to the level of its closest peers which could imply a doubling of current margins and could lead to 100-200% upside from current levels.  Downside should be protected due to the company's very strong balance sheet and consistent profitability.

Capitalization and Valuation

VTU has 199mln shares outstanding for a market cap of 58mln at 29.25p.  The company has 24mln of cash and 10mln of debt for a total EV of 44mln.  FY 11 revenues were GBP 1.0bln (0.04x revenues) and FY 11 EBITA was 8.7mln (5.1x).  Tangible book value per share is 39.5p (0.74x). 

Upside

Upside at Vertu will be driven by the company's ability to improve profitability at recently acquired loss making dealership.  Industry peers LOOK and PDG have EBITA margins for their auto divisions (they have other businesses) of ~2% while VTU has an EBITA margin of 0.9%.  If the company is able to achieve a 1.5% EBITA margin, then it would generate 17mln of EBITA and 6p of EPS suggesting a value of ~60p per share at 6x EBIT and 10x EPS.  With a 2% EBITA margin, the company could be worth 75-85p.  Looking

Vertu aims at buying severely underperforming dealerships and implements a 4 year plan to restore profitability which focuses on installing a new management team, rationalizing operating expenses and investing in the creation of a customer database to drive aftersales penetration (critical due to its stability and high profitability).  Given the timing of its acquisitions (almost 50% in FY 10-12), the company is still in the investment period of its turnaround plans but should begin to see improved profitability in the future.  As an example of the success of this strategy, VTU points to its acquisitions of 4 Citroen dealerships in 2008.  The first year after they were acquired, the businesses lost GBP 500k.  After the implementation of the VTU turnaround strategy, the dealerships earned GBP 861k in FY 11, an over 2% return on sales compared to 40bps for the business as a whole. The company still has plenty or room to acquire smaller dealerships as the UK industry remains very fragmented (66% of the market in 2010 was still held by companies outside the top 40).

CEO Robert Forrester was highly regarded as the finance director of Reg Vardy PLC which was considered one of the most successful UK volume dealers before its acquisition by rival Pendragon. Forrester owns over 6mln shares is viewed as hardworking with an intense focus on customer service (apparently he answers every customer service email personally).  Checks on Forrester have come back universally positive with peers viewing him as both a disciplined acquirer and savvy operator of volume motor franchises.

Further upside could come from a recovery of the UK automotive market which is currently seeing new car sales at levels not seen since 1995.  Given that the number of dealerships have shrunk 15% since 2005 and will continue to shrink due to continued weak demand, surviving, well-capitalized dealers should have a larger portion of the market when (if?) it recovers.

Downside

VTU has a strong balance sheet with net cash, an overfunded pension and freehold land (which is potentially understated on the balance sheet.  At 19p, the company would be trading at 1/2 tangible book with a consistently profitable business. 19p would also be ~6x 2012 EPS.

Risks

1. UK economy goes off a cliff
2. Turnaround plan fails and margins do not improve
3. Bad acquisition

Catalyst