Stern Groep — A strong H1, more emphasis on used/rental

Despite uncertainty in the car market, there are a number of opportunities that could start to crystalise value for shareholders. For more detail, please see also Edison’s interview with CEO Henk van der Kwast (www.edisongroup.com/edison-tv/stern-groep-executive-interview/).

In the last few years, Stern has been proactive in restructuring the organisation to keep up with the structural change in the automotive market. A key part of that has been the progress made in digitalisation of sales and service operations, in which it was lagging Dutch peers. Looking forward Stern now sees OEMs moving towards an agent model, which implies a large change in the operating environment compared to the current dedicated dealer model, and this could trigger further consolidation. Furthermore, Stern believes that the interest in rent/short lease and relatively new used cars will continue as modern car users want flexibility. To summarise:

Stern’s H121 results were still heavily affected by the pandemic, with closed dealerships in Q1 and a recovery in Q2 when dealerships were opened again. Used cars were in strong demand (sector organisation VWE: +6.7% in H121), as well as light commercial vehicles (sector organisation RDC: +30% in H121), while new car sales (sector organisation RDC: +3.3% in H121) lagged.

For Stern this meant that H121 sales came in higher than our expectations at €419.5m, an increase of 10% y-o-y, compared to our estimate of €401.1m. Stern sold approximately the same number of new passenger cars in H121 compared to H120. As such, its market share decreased to 4.1% from 4.4% in H120, although it marks an increase compared the 3.8% reported over FY20. The flat volume development was partly caused by Stern deciding to postpone deliveries to January from last year as a result of lockdown measures at that time, which was offset by lower deliveries in Q2 as a popular EV model became available later in the quarter than expected. Average selling prices of new cars are clearly higher.

Gross margin for the group came in lower at 17.7% compared to 18.0% in H120, driven by mix effects because of relatively lower workshop revenues, as traffic on the Dutch roads did not recover as much as was expected, partly offset by higher margins for new and used cars.

Adjusted EBIT came in at €7.9m (was €6.4m in H120), compared to our estimate of €8.1m. We have adjusted for negative one-off effects of €0.5m related to restructuring. Government support measures (NOW) continued to support Stern’s results in H1. The support will continue in Q321, after which it will probably stop.

Very strong operational dealer division results were offset by a €3.2m lower valuation benefit of the Bovemij participation and lower than expected results from Stern Mobility Services, both in rent and car services. All in all, reported EBIT was €7.4m compared to a loss of €14.9m in H120, which included a large impairment charge. Net profit amounted to €5.1m compared to a loss of €19.0m in H120.

The pandemic has affected and still is affecting Stern in several ways. Showrooms have been closed for parts of 2021 and working from home continues to be encouraged, leading to less traffic and less accidents, etcetera. Given the supply chain issues relating to chip shortages for the OEMs (also an impact of COIVD-19), it is uncertain how the year will progress and as such Stern did not provide specific FY21 guidance, but it expects a further improvement of results in H221.

The 2020 tax asset/goodwill impairments have resulted in a solid, fully impaired balance sheet. In H121, Stern’s equity ratio came in at 32.2% compared to 28.9% at the end of 2020. Net debt amounted to €92.8m (FY20: €104.2m) as the balance of long- and short-term bearing debt (€8.6m and €85.0m) and cash of €0.7m.

Where we had expected a decrease in operational cash flow in H121, there was a large cash inflow of €28.3m, after the strong cash inflow of €45.5m in 2020 (€8.7m in 2019), as working capital (stocks of new cars) were significantly lower. The operational cash flow was partly used for investments (cars for the rental fleet) of €9.8m and the redemption of interest-bearing debt of €10.9m.

With the progress that we have seen in underlying results and activities, a strong balance sheet and with the now fully impaired asset base leading to a book value of €23.01 for H121 (FY20: €22.19 per share), Stern seems to be well positioned for the uncertain market environment in 2021.

After a 20% drop in new car sales in 2020 to 356,051 in the Netherlands, sector organisation Aumacon now expects a stable market of 360,000 new cars (it was previously expected to rebound 16.6% to 415,000), while sector organisations RAI and Bovag still expect a rebound of 12.3% to 400,000. Given that H121 new car sales were only 3.3% higher, this might seem very challenging. However, as Q120 was still pretty strong and Q220 was the first fully COVID-19 affected quarter, we believe a high single-digit increase in new car sales is plausible based on the anticipated further economic recovery in H221. However, we note that new car sales levels are still well below pre pandemic levels.

While we already expected a much more modest recovery in our FY20 update, we have further trimmed our new car sales estimates. However, driven by a greater proportion of more expensive EVs and SUVs with higher average selling prices (ASPs), the total revenue effect is positive. All in all, we have increased our FY21 revenue estimate by 2.2%.

Gross margins developed well in 2020 driven by mix effects (relatively more higher-margin workshop revenues) and that effect is levelling off as the pandemic eases. However, increased traffic will also lead to more car accidents and maintenance, which will benefit Stern. FY21 gross margins on new and used cars are higher given the low availability leading to higher prices and on balance we estimate a slightly higher gross margin of 18.3% for FY21 (FY20: 18.2%).

Opex was lower because of cost reductions and lower than expected staff expenses, partly due to government support measures (NOW) and restructuring. We have decreased our opex estimates for FY21 given the strong execution in H1, but increased our depreciation estimates (more rent cars) and arrive at an adjusted group EBIT of €13.9m (+3.7% compared to our previous estimate) for FY21. We consider that government support measures will end this year, which will lead to higher staff costs in H2. For 2022, we increase our EBIT estimate by 2.2% to €17.0m.

As a result of lower tax charges, we expect net profit of €8.8m (vs €8.4m) in 2021 and €12.0m in 2022 (vs €10.9m).

The most important factor in Stern’s profit and loss accounts are the Dealergroup results, as they generate the bulk (~95%) of revenues. EBIT in this division impressed with €9.7m (H120 adjusted: €2.6m) as a result of lower opex and was above the 2% level that is targeted (2.5%). This is partly because of government stimulus that is not expected to continue as of Q4.

We expected Stern’s new passenger car revenues to rebound 9% to €383m in 2021, following a 20.8% decline in 2020, based on the average sales estimates from ING and sector organisations RAI/Bovag and Aumacon. With new car sales roughly around the same level as last year, with higher ASP’s in H1, we now expect 9% higher FY21 revenues, also because many EV’s from the order book that were not available in Q2 from one popular model, will now be delivered in H2.

On the other hand, used car sales seemed under pressure in the first months of 2021 and have rebounded to a plus 6.7% for the first half year. We expect Stern to win some market share there (+7% revenue growth), because it is better positioned to collect new supplies with its partnership with ALD and the own rental fleet. Importing cars has been more difficult, as demand is high European wide.

Light commercial vehicles showed a 30% volume increase in H121. Our previous estimate for Stern in 2021 was a 17% revenue increase following the 43% decrease in 2020. Ford, Mercedes and Renault are all doing very well in this segment, and these are Stern’s stronger brands. We estimate 28% higher revenues in 2021 now. For maintenance and parts, we have reduced our estimates from 5% growth to decreases of 2%, as demand for mechanics decreased as a result of less accidents and lower demand for maintenance as traffic in The Netherlands is not yet on pre pandemic levels.

All in all we have increased our 2021 top line estimates for the dealer division slightly (+0,4%) to a growth of 8.5% to €842m. For the years ahead we expect moderate growth towards the 2019 level of €900m sales again driven by higher car sales (new and used).

We estimate somewhat lower gross margins as maintenance/parts revenues decrease and decrease our opex estimate by €3m after the decrease in H121. All in all, our adjusted EBIT for the dealer division is expected to be €16.3m in 2021 vs €8.8m in FY20 as a result of stringent restructuring, especially cutting down on staff and locations, gradually increasing to €17.1m by 2022. This means that the 2% margin target for which Stern strives seems within reach for 2023 with already 1.9% in FY21e (H1: 2.5%).

This is the first time that mobility services and car services were reported as one division. Revenues in the combined division decreased 26.0% to €33.1m in H121, driven by the lower number of accidents on the Dutch roads leading to lower revenues in car services and also much lower remarketing income from rental cars, as the fleet was much smaller than in H120. The EBIT loss amounted of €0.2m (H121: loss of €1.1m).

With 2,400 rental cars by July (FY20: 1,968), the rental fleet is increasing rapidly again. By 2022, the rental fleet should be getting back to more normal levels of around 2,700. In Car Services, we expect growth to accelerate as the pandemic fades out, partly driven by the service level agreement with ALD (oil refreshing, winter/summer tyre changes, bodywork repairs for lease cars), but also market recovery, as much repair work has been postponed in the current economic environment. We conservatively forecast stable gross margins and opex of about €28.0m pa, and EBIT margins should recover to 2.4% by 2022 from 0.4% in 2021 and -2.7% in 2020.

Group costs (labelled other) are stable at around €2m in our forecasts but include one-offs that make the final results very volatile. H121 was affected by a one-off charge of €0.5m as a result of restructuring. Also, the revaluation of Bovemij is in this result and this is also a very volatile component. As the increase of the valuation of Bovemij was €3.2m lower compared to last year, this resulted in an EBIT loss in other of €1.7m. For FY21 we now calculate a €2.7m loss.

Stern’s valuation compared to international peers continues to be on a much lower level on adjusted P/E. Among other things, this could be explained by the fact that Stern’s profitability is generally lower compared to international peers, especially the Scandinavian companies, and because of the relatively low liquidity. We continue to believe that the current share price does not take into account the potential for significant dividend payments in the future, a liquidity event from its participation in car insurer Bovemij and/or M&A.

Stern’s operations are moving to satisfactory levels with operational (EBIT) margin in the dealer division already at >2% levels in H121, although this is a bit distorted by government support. We currently model group EBIT margins to gradually recover to 2.1% by 2023 from 1.7% in 2021. In the coming years, changes in the dedicated dealer model for OEMs could change to an agent model, in which case we would expect some pressure on margins, but a much lower capital intensity and this should provide multiple expansion on a P/E ratio level. In H121, net debt decreased to €92.8m (FY20: €104.2m) driven by a strong operational cash flow.

Overall, noting the difference in capital structures and quality of balance sheet in the peer group companies, we consider P/E as a more relevant valuation metric for the sector. We apply the average FY22e P/E of the comparable European dealership holdings to our FY22 adjusted EPS estimate of €2.12 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 €27.31 per share (previously €26.70 per share).