Carsales.com (ASX:CAR) is increasing investment on its key growth initiatives for its Korean operations. It expects a significant pay-off should these growth initiatives be executed successfully. The growth of the international operations, coupled with the dominant market position in online classifieds are the key investment considerations. Accordingly, we recently undertook an assessment of these factors to determine whether the shares, after a period of weakness since the release of interim results in February, now present an opportunity.
Carsales.com (CAR) is the largest aggregator of online automotive classified advertising in Australia. Online advertising in Australia is undertaken across three platforms: Display, Private, and Dealer listings. In addition to its domestic operations (which account for over 75% of group revenue), the Company has interests in leading international automotive classified businesses, mostly in Korea (100% interest in SK Encar) and Brazil.
The Company has a strong market position, which continues to improve. Notably: i) 9x more time is spent on carsales.com than its nearest auto competitor, ii) The time to sell has reduced by 40% and iii) CAR has a unique audience 4.5x more than its nearest auto competitor.
Key Fundamental Drivers
1. Domestic Demand Remains Strong Despite Inventory Challenges
Inventory levels in both private and dealers remain low. This is partially offsetting an otherwise high velocity of leads and sale conversions on the platform. CAR reported a 25% decline in inventory across its global platforms.
Despite challenges from low inventory, demand indicators remain strong. In particular, more flexible work arrangements (as a result of COVID-19) are making driving more attractive and the Company has seen an acceleration to online with a consumer preference back to car ownership. The key factors driving the latter them include preference for vehicles over public transport, closed borders increasing domestic holidays, instant asset write-off programs and early access to superannuation. Interestingly, CAR could benefit when the preference for vehicle unwinds and private vehicle listing returns as public transportation returns to normal.
2. Can the Display Segment Recover from Structural Challenges?
Since 2018, CAR’s Display revenue growth has been negative, due in part to fewer units of new cars sold in Australia, thus reducing demand for advertising of new models. The weakness is also attributed to the advertising industry’s move towards programmatic digital advertising purchasing. In 1H21, Display revenue was impacted by a challenging advertising environment due to the significant reduction in new car sales and associated reduction in advertising budgets for Original Equipment Manufacturers.
Display ads are expected to see “good growth” in 2H21, as a result of new car volumes turning positive in December 2020-January 2021 after having been negative for three years. However, the Company noted that despite new car sales returning to growth, advertising budgets are proving slow to recover.
3. Assessing the Growth Opportunities for SK Encar
The acceleration in the growth rates for both revenue and EBITDA reflect online migration driven by COVID-19, strong growth in Dealer Direct and Home Delivery products, and solid standard dealer listing volumes. Planned investments into growth initiatives such as Dealer Direct, as well as strong momentum in SK Encar listings are expected to support revenue and earnings growth from FY21 onwards. To this end, there are two key medium term revenue drivers for SK Encar:
Dealer Direct Product
Dealer Direct is similar to CAR’s Instant Offer product, with the key difference being the pricing approach. Under Dealer Direct, price is established via a virtual auction process, whereas the carslaes.com determines the price for Instant Offer using its own pricing engine. Instant Offer allows a private seller to sell their car to a dealer at a transparent price
By way of background, total vehicle sales transactions in Korea (new and used cars) are 5.0 million. Of this amount, 1.5 million comprises physical (i.e. offline) trade-ins, which is beginning to migrate online, with offline transactions growing at 50% per annum. In contrast, offline trade-in transactions are decline at 5% per annum.
At present, CAR has low double-digit penetration of the online trade-in market, which comprise only 10% of the total trade-in market. There is potential for CAR to capture additional share of an increasing segment of the market (i.e. online trade-ins could grow from 10% to ~30% over the medium-to-longer term) given that SK Encar, which has the largest auto classifieds audience in South Korea and a large dealer customer network, can leverage the Dealer Direct product. Further, online car purchasing in South Korea remains at extremely low levels (~3%).
Guarantee is a valuable product for Korean consumers and has experienced strong growth as it allows consumers to filter for genuine/reliable product. Guarantee is estimated to account for ~20% of the listings base, but 4x the price of a standard ad. As such, the revenue growth potential could be significant and could be augmented by price increases (which has not occurred for nearly two years).
4. Gearing Levels Remain Manageable & Continue To Reduce
The Company typically generates strong cashflow to service its debt levels, even when gearing levels have been higher. Cash conversion is usually high, although the 1st half is slightly seasonally weaker. In 1H21, cash conversion was 111% of EBITDA, which helped allow CAR to reduce debt. Accordingly, gearing (on a net debt to EBITDA basis) as at 31 December 2020 declined to 1.5x, from 1.7x as at 31 December 2019.
Aside from the growth opportunity in South Korea, the key drivers for the domestic business are the migration towards a digital automotive marketplace and further development of the Instant Offer product, both of which (as in South Korea) remain in early stages of adoption.
These factors underpin the premium rating typically assigned to the share price. However, the premium rating is now lower than recent levels and now does not appear demanding in the context of forecast EPS growth of ~14% over FY20-23 on a CAGR basis, especially given that there is upside to this EPS growth profile should CAR successfully execute the digital strategy (especially in South Korea).
The CAR share price has struggled since the October high. It has formed a couple of lower lows, and then the last few weeks has seen the share price rapidly fall back towards support. near $19 and then break it. The severity of the recent dip is telling us that CAR will probably have further to fall after any short-term bounce. If CAR does stay under support here at $19 in the next few days, then investors can be patient and wait for lower levels.
Michael Gable is managing director of Fairmont Equities.
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