Marshall Motor Holding — Outperforming its markets

Despite a market that remained less favourable throughout the second half of the year, MMH has announced FY17 results that were broadly in line with expectations. The main highlights are summarised below:

The disposal of the leasing business was completed in the final quarter, essentially eliminating net debt of the ongoing operations, which are now focused on the retail operations of the group. The company also boosted net assets, which stood at 248p per share at the end of 2017, up by 32% and supported by the large portfolio of long leasehold and freehold property.

In terms of trading, the Retail operations generated an overall increase in gross profit in H217, which was essentially a like-for-like comparison against a tougher new car market backdrop. The first half had benefited from the additional contribution from Ridgeway, which was acquired during H116. All three of the subsegments (new car sales, used car sales and aftersales services) improved gross contributions in the second half over the prior year. Retail gross margins finished some 17bp up for the year, mainly due to an improvement in the high margin aftersales activity.

In new car markets, after reaching a record level in the first quarter, registrations fell significantly and persistently as confidence from consumers ebbed away in the face of political and Brexit uncertainties. The situation was further exacerbated by the pull forward of sales into the first quarter resulting from the introduction of new vehicle excise duty (VED) rates from the beginning of April. In addition, adverse publicity with respect to personal contract plan (PCP) finance and diesel engine emissions severely affected buyers’ choice of the fuel.

Against this market environment, MMH recorded a new vehicle unit sales increase of 9% to 53,308 cars (FY16 48,884), which represented a like-for-like decline of 7.5%. Interestingly, while the retail segment of the market showed a sharper decline in 2017, MMH actually outperformed with a like-for-like decrease of just 2.8% in retail units. The balanced portfolio of volume, alternate premium and premium brands provided a supportive platform. Alternate premium and premium brands account for 75% of sales and outperformed the market trend. Boosted by the full year from Ridgeway, the overall improvement in retail demand was 12.3%, accounting for around 60% of overall group new car sales.

By contrast, fleet sales dropped 13.9% against a market decline of 4.7%. The performance reflected the already announced decision to withdraw from some lower-margin activities.

In common with other large motor dealership groups, the use of PCPs remains an important tool in the affordability of new cars for buyers. 83% of customers buying new cars on finance from MMH utilised PCPs in 2017, and it had almost 67.5k customer PCP contracts in force at the end of 2017. The concerns over PCP utilisation appear to be abating, with an awaited report from the FCA towards the end of this month, and management expects to give them a largely clean bill of health. It is also anticipated that while monitoring of credit risk and regulatory requirements may be stepped up, the larger dealership groups such as MMH already apply rigorous standards to any offer.

PCPs are regarded as beneficial in retaining customer engagement when renewals are due. In addition, PCPs provide a forecastable and high quality source of vehicles for used car operations, as well as supporting aftersales service volumes.

MMH’s performance in the used car segment was impressive in what was a slightly softer market. Volumes grew by 17.1% to 44,237 units, up 5.2% like-for-like. In turn, this drove revenues up by 21.1% (7% like for like), and while gross margin slipped modestly to 6.9% (FY16 7.1%), the gross profit contribution was also up almost 20%.

Again PCPs play an increasingly important role in the used segment with 58% of the group’s 2017 sales utilising the product. As with new cars and the ability to offer service plans to customers on quality vehicles, the use of PCPs provides support for the aftersales operations.

Aftersales is a very high gross margin activity operating in the more mature growth environment of the overall car parc, and MMH’s position within that. The addition of Ridgeway drove sales up 20.0%, 2.3% on a like-for-like basis. The customer base has continued to grow in recent years thanks to strong new and used vehicle sales, as well as the penetration of the aforementioned PCPs and service plans. The group had over 77K service plans in force at the end of 2017. Customer service and experience remains of paramount importance in client retention. Gross margin increase by some 130bps to 46.9% in 2017, and the contribution to gross profit increased 23% to £114m, or 44% of the total for the continuing Retail business.

The Leasing business was sold on 24 November 2017 for a gross consideration of £42.5m. Its contribution was down slightly on the prior year during its period of consolidation. Management also closed six subscale loss-making businesses during 2017.

The trends apparent through the second half of 2017 have persisted into the current year. The SMMT forecast for the current year is for a 5.6% decline in new cars, which still implies a strong market in an historical context. At 2.56m units 2017 was still the third-best selling year ever following the record 2.69m units in 2016. The first-quarter comparisons will be the toughest but these should progressively ease as the year progresses.

Operating in this environment management has indicated no change in its expectations for FY18 after considering year-to-date trading. We have tweaked our numbers modestly following the confirmation of FY17 performance, but essentially we leave our FY18 earnings estimates are unchanged.

It shows modest year-on-year decline which we expect to start to reverse in our 2019 estimates which we introduce for the first time.

The balance sheet is now essentially ungeared with net debt of just £2.2m at the year end, following the disposal of Leasing and its associated asset-backed debt. Together with its significant banking facilities the group is well positioned to pursue value creating opportunities in the sector as they arise, with the softer market environment anecdotally starting to lower vendor expectations.

In addition to £6.8m of restructuring costs and the £36.9m profit on the leasing disposal, the company took a £6.0m provision in FY17 included in non-underlying items that is the estimate of the cost of withdrawal from the Marshall Group Executive Pension Plan. MMH has no active members of the scheme and it is the last defined benefit pension scheme exposure for MMH.

The dividend increase of 16% to 6.4p for 2017 provides an attractive yield of 3.8% that remains covered 4.2x by underlying earnings of the continuing businesses. We feel this has played an important role in providing share price resilience for MMH, which has allowed it to close the rating gap to some of its peers. Auto retailers remain cautiously rated by the market compared to the more general retail sector, but we think as the larger groups continue to display resilience in tepid markets, the market should start to increasingly respect the value afforded.