A very profitable year

New passenger cars sales volumes were down 19% in the Netherlands in Q321. This was mostly driven by a lower availability of cars because of supply chain issues, especially due to chip shortages. Commercial vehicles sales were down 11%, after a strong increase in H121. However, used car sales were up 5.5%. The first nine months of 2021 are a record in the Netherlands for used car volumes with over 1m cars sold so far this year.

Average prices of cars sold were much higher in Q321 as OEMs are prioritising the delivery of premium cars, which carry higher margins, and a higher percentage of electrical vehicles (EV), which are also higher priced on average. In this mixed market environment, Stern reported 1.4% higher revenues of €200.5m and a marked increase in market share in new passenger car sales (from 4.0% in Q320 to 4.3% in Q321) as well as a smaller increase in the market share of commercial vehicles (6.3% compared to 6.1% in Q320).

Although Stern’s trading update does not specify margins, we assume that there has been a strong improvement given the increase in net profit. Gross margins rose due to the higher percentage of premium models and EVs that were sold as well as a strong negotiating position for dealers given the overall supply/demand situation. Staffing costs were 10.9% lower compared to Q320, driven by staff reductions and COVID-19 related government aid and general costs were 5.6% lower following a cost saving programme. As a result, net profit in Q321 was €2.9m versus a loss of €3.2m in Q320.

As we noted in our previous report, after years of downsizing, Stern is now looking to expand again. With the Q3 trading update the company reported the acquisition of two Opel locations (Vauxhall in the UK and part of Stellantis, which also includes Alfa, Peugeot and Fiat) and two Opel agencies, which will be completed in early 2022. In addition, Stern will divest two other Stellantis locations. Later in 2022 Stern will further expand the Stellantis activities in the Dutch provinces of Groningen and Drenthe, in line with Stellantis’s strategy.

Stellantis (and Mercedes) are moving in the direction of an agency model instead of a dealership model for car distribution and Stern taking over Stellantis locations is certainly a move in that direction. This new operating model probably implies that there is no need for most of the new cars that are now on the dealers’ balance sheets, implying much lower working capital requirements. Of course, this will be at the cost of gross margin for the dealers, but the return on investments will probably be much higher and the balance sheet risk will be lower, implying higher valuations.

Furthermore, ALD and Leaseplan are (now officially) in talks about a potential combination. ALD is a very large client and contract partner for Stern, as it acquired Stern’s lease division in 2019 and the two signed a service level agreement on lease contracts closed at Stern and the repair and maintenance from these contracts. Leaseplan is much larger in the Netherlands than ALD and Stern sees the potential combination as an opportunity to increase sales to the combined entity.

Q3 has been very weak in terms of passenger car sales volumes and sector organisations RAI and Bovag decreased their FY21 new passenger car sales estimate drastically to 327,000 (compared to 356,051 in 2020) on 11 November 2021 from 400,000 at the time of the publication of Stern’s H1 results. For 2022 RAI and Bovag expect a recovery to 390,000 (+19%). Aumacon, the other Dutch sector organisation, also decreased its passenger car sales estimate for 2021 to 335,000 in October (from 360,000).

Although the volume decrease in new passenger cars was in part offset by higher average prices and better used cars sales, we have reduced our sales estimate for 2021. We now expect revenues of €801m, down 4.4% compared to our previous estimate. For 2022, we now assume 7.7% revenue growth, driven by higher car sales volumes and partly offset by lower average prices, down 1.2% compared to our earlier estimate.

However, car shortages and a better mix (relatively more, higher-margin workshop revenues) have also led to significantly improved margins. Also, Stern expects that new car volumes will not recover markedly in Q4 given the shortage issues of new cars and the order book will probably continue to increase. As a result, we have increased our gross profit margin estimate. Nevertheless, lower sales mean total gross profit will probably be lower at €150.6m (compared to our previous estimate of €153.3m). As a result of the realised cost savings and better mix, our EBIT estimate goes up by 14.8% to €16m for 2021. In 2022 we expect Stern to remain stable, given the closure of government support programmes and a return to a more normal market (pre COVID-19) environment.

Stern’s Q421 guidance is for a further improvement in results compared to Q420 (€1.2m net profit from continued activities). On our new estimates, we now expect an increase in FY21 net profit of 19.8% to €11.1m (previous estimate €8.8m) which would mean a Q4 after tax profit of €2.6m. This is also the highest level since 2007 (adjusted net profit). For 2022 we forecast a net profit of €11.2m (previous estimate €12m).

Stern’s balance sheet remains solid with an equity ratio of 33.5% compared to 28.9% at the end of FY20.

We believe that Stern has shown a consistent performance in the pandemic by restructuring significantly and by realising a much lighter balance sheet in recent years. We see the acquisitions that were announced with the Q3 trading update as a sign that it is gearing up for growth again. Its valuation is undemanding at 7.1x FY22e P/E, which is much lower compared to international peers.

Stern’s structural undervaluation can in part be explained by the fact that its profitability is generally lower compared to international peers, especially the Scandinavian companies, and because of the relatively low liquidity of the shares. We continue to believe that the current share price does not consider the potential for significant dividend payments in the future, a liquidity event from its participation in car insurer Bovemij (which could be sold, see previous notes), and/or further M&A.

Stern’s operations are moving to satisfactory levels with operational (EBIT) margin in the dealer division probably already at the targeted >2% level in FY21, although this is a bit distorted by government support. For 2022, we pencil in a somewhat lower margin that will recover to 2.1% by 2023. In the coming years, changes in the dedicated dealer model for OEMs could change to an agency model in which case we would expect some pressure on margins, but a much lower capital intensity, which should provide multiple expansion on a P/E level. In H121, net debt decreased to €92.8m (FY20: €104.2m) driven by strong operational cash flow.

Overall, noting the difference in capital structures and quality of the balance sheet in the peer group companies and different accounting policies, we consider P/E as a more relevant valuation metric for the sector compared to EV/EBITDA. We apply the average FY22e P/E of the comparable European dealership holdings to our FY22 adjusted EPS estimate of €1.96 and add the book value of the Bovemij stake (which we estimate at €3.47 per Stern share), arriving at an implied value for Stern of €25.23 per share (previously €26.70) per share).