It’s not often you find a company with operating margins above 60%, but when you do its well worth taking a closer look. That’s the case for Auto Trader (LSE: AUTO), whose reported operating margins in the year to March 2016 rose from 52% to 60% year-on-year.
The key to margins so astronomically high is the company’s business model of running an asset-light online platform that charges private sellers and dealers a fee to list their automobiles on the service. And because the company’s website brings in an average of 250m views per month it can charge customers a hefty fee. In H1 2016, the average fee per retailer rose 13.3% year-on-year to £1,526 per month.
This helped boost revenue during the period by 11% to £153.9m. And with just 830 employees and contractors in the six months, operating margins rose to a whopping 65%. The company is also assiduously slimming down its overall capital expenditure and reducing marketing spend as a percentage of revenue as sales grow.
These actions helped increase operating cash flow to £101m. The bulk of this was used to repurchase £49m worth of shares with an additional £25m directed to reducing the pile of debt the company’s former private equity owners saddled it with before taking it public. These payments reduced net debt to £359m at period end, which brought leverage down from 2.2 times EBITDA to 1.8 times.
There are concerns that the company could face declining numbers of customers in the coming quarters as a huge stock of leased vehicles hit the used car market, which would dent small car dealerships’ margins and force some out of business. This may be beginning to play out as total advertisers in H1 declined 1% year-on-year.
Still, with the company growing sales, profits and cash flow at a rapid clip there’s plenty of reason to be interested. As the company whittles down its debt, there’s also plenty of potential to increase share buybacks and begin dividend payments. With its shares pricey at 26 times earnings, a significant amount of growth is baked into valuations. But Auto Trader is still one growth share I’d love to own.
Just a wee bit lower margins
One of Auto Trader’s many large customers is car dealership Vertu Motors (LSE: VTU). Unsurprisingly, running a chain of bricks and mortar dealerships is a significantly less profitable business than hosting an online bulletin board. Vertu’s operating margins clocked in at a meagre 1.3% in the six months to October, the last period for which financials were reported.
Still, the company is growing quickly and its rollup model of acquisition has transformed it from the UK’s 13th largest dealership group in 2007 to the fifth largest today. This growth is continuing at a rapid rate and in the final five months of the financial year, revenue grew 16.6% year-on-year, thanks to acquisitions and a very solid 4.8% bump in like-for-like sales.
It’s also encouraging to see high-margin and less cyclical services make up an increasing percentage of overall sales. In H1 they accounted for 7.8% of revenue, up from 7.6% the year prior, and made up a full 39.4% of the group’s gross margins.
If the economy continues to grow at a steady rate, investors may find Vertu’s business model of ‘acquire, improve margins and acquire again’ an attractive opportunity. And with the company’s shares trading at just 7.9 times forward earnings and offering a 2.7% yield, there’s plenty more to like.
But if you’re looking for a higher margin growth share, I recommend reading the Motley Fool’s free report on one company that has doubled sales, profits and dividends all in just the past five years. The market hasn’t ignored this stellar performance and shares of the company are up over 200% in value over that time.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Auto Trader and Vertu Motors. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.