COMMENT
Shares That Could Break Down

By David Kuo (TMFDragon)
December 15, 2004

Two years ago, Mintel said new car prices in the UK were still around 10% more expensive than in the other EU markets. Since then, motoring organisation SMMT has reported a fall in car forecourt prices. This has been corroborated by Alliance & Leicester, which has said that the cost of buying new and used cars has fallen 9% and 25% respectively over the last five years.

It is widely recognised that car prices have been driven lower by competition. In fact, declining car prices have boosted the volume of cars sold to near record levels. However, successive interest rate rises since autumn 2003, and a slowdown in the housing market-led credit boom, is expected to have a dampening effect on big-ticket items.

This does not bode well for car dealers. Furthermore, changes to the block-exemption system have meant that garages can market their cars in different areas. Additionally, dealers can also sell more than one make of car on the same site. Consequently, dealers may be forced to consolidate further to improve efficiency.

Taken together, this implies greater uncertainty for motor dealers such as Pendragon (LSE: PDG). The used and new car merchant is penciled in for annual profits of £60m this year, but earnings are not expected to improve much above this level next year.

Profit growth at European Motor Holdings (LSE: EMH) is expected to stall too. The motor dealer, which also services cash-washing equipment, is expected to post an 8% rise in profits to £15m in 2005. However, profits are anticipated to be unchanged from this level in 2006.

Interestingly, Inchcape (LSE: INCH) has already flagged up difficulties in the British car market. The company warned earlier this week that its UK business was behind target. Nevertheless, the car importer and distributor, which generates 66% of its sales outside Britain, still expects total profits to be ahead of expectations.

Elsewhere, Reg Vardy (LSE: VDY), which posted unchanged interim profits of £24m recently, said demand for cars declined for the first time in a number of years. However, turnover climbed 7% to £850m, resulting a reduction in operating margins from 2.7% to just 2.4%  

In my opinion, the road ahead looks bumpy for car dealers. Currently, car sellers are valued at P/Es of around ten times earnings. This looks cheap at first sight. However, investors should take care because profit forecasts may be revised lower. Furthermore with margins thinner than panels on new cars, it won't take much to dent these shares!