We don’t really have an automotive industry in the UK any more, but through the magic of the stock market we can still invest in the sector. It begs the question though, where did all those companies go to?
Land Rover, Jaguar, Rover, Vauxhall... where are they now? As with so many investment questions, the answer is China. The manufacturing capacity and cheap labour in Asian countries makes for a wholly more profitable industry and a better return to shareholders despite the grievances we all feel about the death of manufacturing in the UK.
However, despite improving profitability, it’s still a tough call on where to invest in this market. Established European and US automakers look long-in-the-tooth. The assumption would be that a major emerging market player is in the ascendancy. After all, auto analysts believe that emerging markets will account for a massive market share in the manufacturing in the next five years.
They also concede however, that an Indian or Chinese national champion strong enough to challenge the likes of GM or Toyota is still a long way away and to get into the likes of China’s Wonder Auto Technology at this embryonic stage would be a risky move.
Hence, the best way to take advantage of these still untapped emerging markets is not at the manufacturing end, but at the more nimble retail level. Ironically, the automotive and the retail business look pretty shoddy as separate entities but lumped together it is a dream ticket... particularly for those operators operating in BRIC markets.
That’s where Inchcape comes in. It is a leading international car retailer operating largely in developed markets across Europe and, Singapore and Hong Kong but it also has significant operations in Eastern Europe, China, Russia and South America making it a great play on the burgeoning emerging markets’ middle class.
Global advantage
Inchcape (LSE: INCH) is unlike struggling rival Pendragon (LSE: PDG), as it focuses on luxury brands like Mercedes-Benz, Audi and BMW, a market its chief executive Andre Lacroix describes as "more resilient" than the discount business model.
Full year sales have increased six years on the spin, with 2007 finishing up 25% to £6.1 billion. This was achieved through a combination of organic and acquisitive growth. Margins were slim at £240m, but this is again a reflection of the firm’s tendency towards buyouts.
Even their UK profits were higher(!), up 52%. However, the firm is on a campaign of disposing non-core UK operations where the market faces growing uncertainty - new registrations have fallen at the fastest rate in 10 months.
For long-term growth, the group’s emerging markets interest are where it’s at. International sales were up at £3.4 billion and represent 76% of the group’s trading profit. As Goldman Sachs research has shown, within the next 15 years both India and China will have more car owners than the US. The global car market is moving towards these emerging markets, including Eastern Europe countries and Inchcape are aggressively ramping up production in the region to cash in on the trend.
"Looking ahead to 2008 and through to 2010, Emerging Markets remain a major expansion opportunity," said the firm. And they weren’t kidding.
Having previously purchased St. Petersburg dealership Olimp, Inchcape acquired Musa Motors in April, one of Russia's largest car retailing groups. The initial consideration was for $200m representing a 75% stake in the company. The deal is set for completion in 2010.
City analysts described the deal as "transformational" and Citigroups’ James Targett said, "With increasing worries about the state of the UK consumer, we find Inchcape's earnings exposure to the UK of just 24% is attractive." The transaction should begin contributing to earnings straight and Inchcape believes it will pushes group revenue expectations to £1 billion.
Sterling weakness spurs growth
The first quarter of 2008 also came in at higher levels, helped in part by the depreciation of the British pound. It might be a source of national humiliation that our currency is sliding closer and closer to the Euro, but a devalued base currency is good news for Inchcape as motors sold overseas boost revenue figures when the foreign currency is translated into pounds. Sales from continuing operations rose 7.2% at constant exchange rates.
One area of weakness was the firm’s Singapore operations as business levels are squeezed by country-wide legislative shifts in custom duties and road usage. However, the outlook for growth is unchanged and the company is looking forward to 2008 with confidence.
With a fair dividend yield and a clear trajectory of international-led growth, Inchcape has a lot going for it. And Inchcape is just one of a raft of firms that saw the danger on the horizon a long time ago and took steps to limit their exposure to the slowdown we are now wrapped up in.
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Theo Casey
