Carsales.com (ASX:CAR) recently completed an acquisition that increases its exposure to international markets. It also has the potential to accelerate already-successful growth initiatives. With this in mind, we recently researched the Company to see if there is an attractive entry opportunity. In particular, do the merits of the acquisition outweigh the risks and how is the existing business likely to perform in the event of an economic slowdown?
Carsales.com is the largest aggregator of online automotive classified advertising in Australia. In addition to its domestic operations (which account for over 75% of group revenue), the Company has interests in leading international automotive classified businesses. These are mostly in Korea (100% interest in Encar) and Brazil.
The Company has expanded into non-automotive classifieds, via the acquisition of a 49% stake in Trader Interactive on 12 May 2021. On 27 June 2022, CAR announced the proposed acquisition of the remaining 51% interest in Trader Interactive it doesn’t already own. This was by exercising a previously-held call option to acquire the 51% interest.
As a result of the Trader Interactive acquisition, the domestic operations are expected to account for ~45% of revenue in financial year 2023 (FY23). The contribution from the international operations expected to increase, and account for a similar portion of revenue.
Key Fundamental Drivers
Sound Strategic Rationale Behind Owning 100% of Trader Interactive
Carsales.com expects the transaction to be double-digit EPS accretive from Year 1, although this will be aided by a number of limited life, non-operational factors, such as tax offsets. Importantly, the key strategic rationale for the transaction is that the proposed move to 100% unlocks a number of growth opportunities. In particular, the total addressable market for non-automotive classifieds in the US is ~16x that of the non-automotive classifieds market in Australia and ~2x that of the automotive classifieds market in Australia.
Accordingly, with Trader Interactive the market leader in recreational vehicles and Motorcycles, and holding overall market share of only ~6% in a digitally immature market. CAR is well positive to increase its penetration into these verticals.
Other key benefits from the 100% acquisition include the opportunity to grow dealer yield through enhanced offerings, as well as an enhanced product offering.
Acquisition Risks are Manageable
Key risks with the Trader Interactive business include: i) Sustained revenue growth may be limited in the core recreational vehicles vertical and ii) Adjacent verticals are yet to be proven.
Also, there is execution risk with CAR’s plans to convert the current subscription-based revenue model for Trader Interactive into a dynamic pricing model.
Trading Conditions For Australian Business Remain Buoyant
Concurrent with the announcement of the Trader Interactive acquisition, CAR provided a trading update, as well as FY22 guidance. This was broadly in line with market expectations. Revenue and EBITDA guidance was $507-509m and $270-272m respectively, implying an EBITDA margin of 53%.
Despite ongoing investor concerns around potential macro slowdowns, CAR outlook commentary across all its markets was robust. The updated commentary flagged the domestic business as showing continued “healthy levels” of demand and increased adoption of growth products.
Within the Australian business, listings remain ~30-40% below pre-COVID levels. However, the velocity of new ads remains elevated. The number of listings to expected increase, as demand moderates. This is given dealers would have more stock and would be looking to increase turnover. In effect, this provides a hedge against reduced demand. Further, CAR has been resilient at increasing enquiry prices despite prior moderations in the automotive market.
As expected, revenue in the Dealer segment, which was impacted in 1H22 by low inventory levels and the extended lockdowns on the East Coast has recovered. This was a result of a price increase implemented in February (+7%) in addition to higher volumes in 2H22 relative to 2H21 (which was impacted by lockdowns).
Elevated Gearing Post Acquisition – But Expected to Decline Quickly
Gearing (on a net debt to EBITDA basis) increased from 1.4x as at 30 June 2021 to 2.2x as at 31 December 2021. This was a result of debt drawdown to fund the initial 49% stake acquired in Trader Interactive. With CAR inheriting Trader Interactive’s debt as part of the acquisition, and the acquisition of the remaining 51% partly debt-funded; the gearing level is expected to increase to ~2.7x.
However, the Company expect gearing to fall <2.0x within two years. This is given that CAR typically generates strong cashflow to service its debt levels, even when gearing levels have been higher. To this end, the CAR management is confident they can deleverage quickly, as shown following the Encar acquisition.
At current levels, we consider Carsales.com’s P/E multiple to be undemanding in the context of forecast EPS growth of ~12% over FY22-24 on a CAGR basis. While this rate of EPS growth factors in the earnings uplift from the Trader Interactive acquisition and continued successful implementation of the digital strategy (especially in South Korea); we consider that there is upside risk to this EPS growth forecast from:
i. Potential for the Company to generate higher-than-expected EPS accretion from the Trader Interactive acquisition (in particular from the implementation of dynamic pricing) and
ii. Market forecasts incorporating, to a greater extent, the potential earnings upside from internal initiatives to continue growing yield for the domestic business via non-price additions, such as Carsales Select; Instant Offer; private yield optimisation and finance commissions.
While there are execution risks from the integration of the Trader Interactive acquisition, the provision of FY22 guidance significantly reduces the risk of ‘sticker shock’ at the upcoming results release in August.
Our charting comment in The Dynamic Investor at the end of June noted that CAR is putting in a couple of higher lows and that current levels might continue to see some good buying support. It still looks as though CAR is building a base here. As long as CAR stays above $18, then the chart is starting to look a bit more positive. A clear buy signal would be a push back above $20.
Michael Gable is managing director of Fairmont Equities.
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