Car dealers have had a great time over the past five years, managing to double their share price whilst the broader S&P / ASX 200 (Index: ^AXJO) (ASX: XJO) has returned a meagre 15%. For the four years since 2009, new car sales have grown at a CAGR of 5.5% per data from the ABS – close to four times faster than the same period starting 2004. This has given shareholders in AP Eagers Limited (ASX: APE) and Automotive Holdings Group Ltd (ASX: AHE) plenty to smile about — both companies have managed to grow NPAT at 15% CAGR whilst maintaining a 4% dividend yield since 2009.
Although sales growth has slowed a little over the last six months, the industry is still on track to record over 1.1 million in car sales. Further, in a recent trading update AP Eagers is expecting a record profit before tax from 2014. It seems like the good times are set to roll, right? To answer this question we must first consider two other questions.
1. Can new cars remain affordable?
According to CommSec new car affordability has hit a 38-year high. One key reason has been price stability – per its report, prices for a selection of cars have only gone up 10% over the past decade even though underlying CPI has gone up 31% over the same period. This stability can be attributed to several factors.
First is the fierce competition in the Australian market. According to the Federal Chamber of Automotive Industries, there are 67 brands selling over 350 models. To put this in perspective, consider that the U.S. market has 53 brands competing for sales, even though the country is over 13 times more populous.
Second is the strength of the Australian dollar. According to Drive.com.au, over 60% of new cars sold in 2013 came from Asia, with 50% of that coming from Japan. Over the past five years the Australian dollar has strengthened against the Yen, mainly due to the scale of Japan's quantitative easing. Given that the Bank of Japan committed last week to increase this measure, the Australian dollar is poised to at least retain gains from recent years.
These factors are likely to be secular (Japan has spent the last 20-years fighting deflation, so it probably won't be resolved quickly), therefore I would argue that new cars should remain affordable.
2. Can new cars become even more affordable?
Sales growth over the last four years has concentrated on 2010 and 2012. Whilst the growth in 2010 can be attributed to pent-up demand as a result of sales declines during the GFC, sales growth in 2012 was largely driven by the RBA's easing cycle. Between November 2011 and August 2013 the bank cut interest rates by 2.25% to a historic low of 2.5%, with 1.75% of that occurring before 2013. With the RBA unlikely to cut rates further as they closely monitor surging property prices, new car buyers won't be incentivised by even cheaper financing.
The CommSec report also cited outpaced wage increases compared to inflation over the past decade as a driver of new car affordability. However the trend has reversed a little with underlying CPI growth outstripping wage growth in four of the last six quarters up to June 2014 – the first time this has happened since December 2009.
It's not all doom and gloom though. A recent report from the productivity commission on the auto industry has recommended scrapping the 5% tariff on imported passenger and commercial vehicles, potentially paving the way for cheaper cars. However, in my opinion, interest rates are the biggest driver and as rates are unlikely to fall further, I would argue that new cars are unlikely to become more affordable.
What's the verdict?
Since the unprecedented growth in new car sales is unlikely to continue, share price gains should also be curtailed in the future. On the valuation front, both AP Eagers and Automotive Holdings Group may look cheap at P/Es of 16x and 15x respectively, but this is comparable to its global peers and probably justified given the lower growth expected over the coming years. Further as both companies are heavily geared, the strong dividend yield could quickly drop off if the operating environment sours.
