Until recently, Auto Trader (LSE:AUTO) was arguably one of the FTSE 100‘s highest-quality growth stocks. A virtual monopoly in the UK online car advertising market combined with incredible profit margins meant investors were paying a premium to own shares.
However, the company’s premium valuation has come under massive pressure, with the stock down 37% since May (and 28% since early November).
This is quite a shocking fall from grace for Auto Trader. But does this make the FTSE 100 stock an attractive dip-buying opportunity to consider?
The company
As mentioned, Auto Trader operates the UK’s largest online marketplace that connects car buyers with retailers and private sellers. In the six months to the end of September, over 75% of all minutes spent on automotive marketplaces were on Autotrader!
As such, it benefits from a powerful network effect. Buyers go there because it has the most cars, compelling sellers to go there because it has the most buyers.
The company makes the bulk of its money through dealership subscriptions (recurring revenue). At the end of September, there were 14,080 of them paying £2,994 per month on average.
Why is the stock down?
Auto Trader’s share price started falling after the firm reported its first-half results in November (covering the six months to 30 September).
There were two main issues. The first was that group revenue increased 5% to £318m, while operating profit rose 6% to £200m.
Management admitted that this growth “was lower than our long-term average due to fast stock turn resulting in both prominence penetration and paid stock being marginally lower year-on-year“.
In other words, growth was weaker because used cars were selling so fast that dealers didn’t need to pay extra for premium adverts.
Revenue has tended to grow at about 10% over the past few years, so slower growth is an issue here. Investors are far less likely to pay a premium valuation for noticeably slower revenue growth.
The main issue, however, relates to the company’s Deal Builder digital tool. This allows a buyer to build an entire deal, including finance and part-exchange, directly on Auto Trader’s platform.
However, some dealers say the reservation part of this process is leading to fewer leads, and a backlash erupted in November when 59 cancelled subscriptions and more downgraded theirs.
In response, CEO Nathan Coe issued a public apology and said the firm was continuing to “seek feedback and refine our offerings“. It will soon offer dealers more choice when it comes to the car reservation part.
Much cheaper stock
This backlash from customers has clearly caused significant near-term uncertainty. However, while most people continue to use Auto Trader to hunt for cars, I don’t think most dealers can afford to leave the platform entirely.
Following the pullback, the stock is now starting to look cheap. The forward price-to-earnings multiple is just 15, while the price-to-earnings-to-growth (PEG) ratio has fallen to roughly 1.4.
For a capital-light platform that boasts a 63% operating margin, I see this valuation as attractive.
On top of this, there are share buybacks. In the six months ended 30 September, it repurchased £100m worth, while the forward dividend yield has risen to 2.2%.
On balance, I see this FTSE 100 stock as a dip-buying opportunity worth exploring further.
