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UK Motor Retail – Supply pressure building

Market conditions have continued to deteriorate in 2018 as new car registrations in September were down 20.5% YoY. Weakness in new car sales in the key month of September, ongoing cost pressures and continuing pressure from OEMs who face their own profitability challenges lead us to take a more cautious approach to our below consensus estimates. Balance sheet strength across the sector is generally robust, and in our view, we are likely to see further consolidation activity once recovery is in sight as smaller operators become more distressed. FCF yields are compelling from next year as major investment projects reach completion.

SMMT data: The SMMT has confirmed that the market was -20.5% in September, which was below our expectations. The declines were seen across all volume categories with private -20.1%, fleet -22.4% and business -6.3% as supply pressures continue to bite. The market is now down 7.5% YTD, with further supply pressures anticipated going into Q1 2019 and beyond. The SMMT forecast registrations for the full year of 2.436m units, implying a 4.1% decline.

Market dynamics: Our expectation was for a 10% – 15% decline in September. WLTP, which we see as a short-term supply issue which is likely to be resolved by Q1 2019, clearly had an impact as expected. The key surprise in the data is the weakness of VW group brands, all of which saw significant declines on 2017, Audi (-53.4%), VW (-55.2%), Skoda (-31.3%), Seat (-36.7%). At an absolute unit level, of the total 87,336-unit decline from 2017, Volkswagen brands accounted for 42,303 of these, or 48%. Stripping these out from the total implies a 13.3% decline overall. Currency weakness as well as UK political uncertainty and Brexit are also having an impact, making the UK a more costly and uncertain place from the perspective of the OEMs, who have varying FX and product cycles, evidenced by recent profit warnings from Ford and BMW.

Forecast assumptions: We are reducing our FY1 forecasts in Vertu and MMH by 10% and 5.0% in FY1 and a further 15.0% and 10.0% in FY2 respectively. For Cambria, we are going to review our assumptions in detail when the Group reports its final results on 21 November. Cambria has undergone major portfolio change in recent months, and we also did not include anything in the forecasts for some of its new brands. With Lookers we are also going to review our assumptions next month when it provides the market with a trading update. We note the acquisition of Jennings Group, which although not officially announced by the company, is expected to be EPS enhancing and our forecasts are already below the consensus range.

Outlook: While we anticipate trading conditions to remain difficult for the foreseeable future, we note all of the companies within our coverage have strong balance sheets, which should prove resilient in a downturn. The market continues to consolidate, and we would expect all of these companies to benefit from this activity. We also anticipate FCF yields to build from next year with an average FCF yield of 11.2% in 2020E based on our forecasts