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UK Motor retail sector SMMT 2016 data – Zeus Capital Partners

The SMMT (Society of Motor Manufacturers and Traders) has released data this morning confirming a record new car market of 2.69m registrations and +2.3% YOY. This is the fifth year in a row of growing new car registrations. Headline December registrations were -1.1% with private registrations -5.5% completing a third quarter in succession of negative growth in this segment. Fleet continues to drive the growth in this market and was +4.8% YOY representing 51.3% of registrations vs. 50.0% last year. The key question is what will happen in 2017 post Brexit with uncertainty levels still high. We maintain our cautious stance and downgraded our EPS forecasts by 8-15% across the sector in November accordingly. That said, we believe the earnings risk has been accounted for in trough valuation multiples based on cautious forecast assumptions (we assume a 10% drop in new car registrations vs. the SMMT at -5%). We continue to favor stocks with flexible balance sheets at this stage of the cycle, and believe stocks such as Vertu Plc and Cambria Automobiles Plc (LON:CAMB) remain significantly underpinned by their growing property portfolios.

SMMT data: Data for December has been released, which was -1.1% YOY at the headline level, marking only the second month of negative growth in 2016, constituting just under 7% of annual registrations. This made 2016 a record year with 2.69m registrations and +2.3%, which was broadly in line with expectations. The SMMT anticipate a more difficult year in 2017 driven by price increased caused by sterling weakness since Brexit. That said, 2017 is expected to remain another competitive year with almost 70 new launches planned over the next 12 months giving consumers significant choice with low cost finance still available. We concur with this view, and believe new car price inflation will be a key issue in 2017 and linked to the performance of sterling over the coming months during a period of uncertainty for the UK economy.

Mix issues: Within the mix, private registrations were -5.5% in December and -0.2% during the year confirming a negative trend we have seen for the last three quarters. Fleet drove most of the growth and was -0.8% in December or +4.8% during the year, with Business +50.9% in December and -1.2% for the year. Notable brand performances for the year included Audi +6%, BMW +9%, Ford -5%, Land Rover +20%, Mercedes +17%, Vauxhall -2% and VW -8%. Clearly some of this performance related to product cycle, albeit there was a pattern of prestige brands outperforming volume again.

Outlook: While 2016 will go down as a record year for the industry, the true impact of Brexit has yet to play out. OEM behavior over the coming months is likely to be FX driven, and we are monitoring consumer confidence trends carefully. New car price inflation will also play a major role in the outcome of 2017 and beyond. We also note the change in tax rules that come into force in April. This could bring forward demand in Q1 2017. The current tax scheme is based on CO2 emissions with new rules slashing this exemption, which after April, will only apply to vehicles with no CO2 emission at all i.e. mainly electric cars. In addition, cars with an official price of over £40,000 will also face an annual “wealth tax” amounting to over £1000 over 3 years in some cases providing an additional cost pressure for the consumer. Elsewhere, we believe demand in the used car market remains strong with volumes expected to be at record levels for 2016 according to CAP HPI, with residual values also robust. We also anticipate trends in the aftersales market to be robust given the rising UK car parc, albeit note potential cost pressures with the apprenticeship levy as previously flagged.

Valuation: On what we consider to be cautious and below consensus estimates across the piece, we believe the sector valuation is attractive for the UK dealers and close to trough levels. Balance sheet strength across the sector is generally robust, and we are likely to see further consolidation activity as smaller operators become more distressed in our view. It would also not surprise us to see further overseas interest in the UK sector given current valuations especially if sterling does weaken further from here.

Catalysts: We believe SMMT new car data in March will be a key acid test of trading post Brexit, and the knock on effect this is having on the used car market. In the meantime, we anticipate FY results from Pendragon Plc (LON:PDG), Inchcape Plc (LON:INCH) and Lookers Plc (LON:LOOK) from mid-February, with Vertu Motors Plc (LON:VTU) also likely to put out a pre-closed statement in early March. The performance of sterling is likely to impact sentiment in the near term, as well as any corporate activity that takes place in the near term as well.