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Following its 20% drop, are Pendragon shares a bargain-hunting opportunity?

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An update on Wednesday came as a body blow for investors in Britain’s largest car retailer, Pendragon (LSE: PDG). New CEO Mark Herbert warned that losses in the first half of 2019 were going to be “significant” – not something we investors ever like hearing. Most notably, the company said that losses in its used car business, Car Store, were accelerating, leading to a build-up of unsold cars, something that had already been happening. At the end of 2018, the company reported £458m worth of used car stock, compared to £372m the year before.

This trend is something that has been reflected across the auto industry in the UK. According to data from vehicle data specialist Cap HPI, May saw the largest declines in used car prices since 2012, as well as large falls in sales themselves. And on the demand side, there has been a broader move from consumers in recent years towards leasing cars rather than buying them outright.

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Road bump?

So the question I have to ask is whether this fall in Pendragon stock is a sign of things to come, or is it simply (if you will excuse the pun) a bump in the road?

Well there are some positives that can be found if you look for them. The firm has a history of paying out a decent dividend, with this year’s first payment coming in at a yield of about 8% at current prices. Of course, this may not last if earnings keep taking a hit, but its dividend growth over the past five years has been above 20%, which should certainly hint at good prospects for investors in the long term.

In addition, and similarly to many UK companies at the moment, the company has in the past blamed consumer caution about Brexit for hurting its sales figures, as well as confusion about the government’s policy surrounding diesel vehicles. If this is true – which is perhaps a big ‘if’ – almost any conclusion of the Brexit debacle should see consumers regaining confidence and certainty. In theory, customers could come back.

Meanwhile, the company’s newly installed management team, though warning that any recovery process would be slow due to a “wide range” of execution issues, is in the process of laying down plans to fix the business, with a strategy update scheduled for September to outline exactly how the team intends to do it. That is something to watch out for.

In many ways, the negatives in this latest trade update are a legacy of the previous leadership team, particularly with its focus on the used car business at a time when that market was lagging. Pendragon has a new-car sales business, a leasing arm and aftersales services to fall back on (or enhance), as well as a dealer management systems software product. This offers the new management team plenty of areas to make up the used car sales shortfall in the coming years. The recovery processes may be slow and difficult, but even if it is not a buy today, I would not write the company off just yet.

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Karl has no position in any shares mentioned. The Motley Fool UK has recommended Pendragon. 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.

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