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Used cars: the tortoise can beat the hare for investors

Cazoo, the UK-based used car online supermarket, declared itself a unicorn last year at its $8bn New York float.

But unicorns are mythical creatures. For investors, it’s better to think of Cazoo as a hare.

Entrepreneur Alex Chesterman started Cazoo in Britain in 2018 to transform the used car market. Now Cazoo vans deliver 50,000 cars a year to the doors of online buyers. There is no visiting a store, no haggling and no test driving. Cazoo offers customers money-back guarantees.

Investors too may wish they had guarantees. Cazoo shares have halved since their IPO. The hare has disappeared deep into the long grass.

A safer way into used cars might be via some tech-minded existing dealers. They may be more of a tortoise than a hare, but as in the old tale that may prove an advantage.

They’ve looked long and hard before leaping. Take Motorpoint — the UK’s only listed used-car-only supermarket. It was launched in 1998 in Derby with a website, a call centre and a showroom in a former abattoir. It has since expanded to 15 click and collect sites, sells close to 100,000 pre-owned autos a year, delivers to the customer’s door, and is forecast to make £25mn pre-tax profits in the year to March 2023 and £40mn the year after.

It is still small, worth under £300m. But that shows how hard it is to foment revolution in used cars. Just 1 per cent of the 8mn second-hand cars sold are purchased online. Motorists may distrust sharp-suited salesmen, but they distrust the web even more.

The market is changing — but slowly. Price comparison sites such as Autotrader have brought transparency. The pandemic has forced shoppers to face their fears of the web. Mark Lavery, boss of franchise dealer Cambria Automobiles, says a decade ago, buyers made four showroom visits before buying. Now they research online and visit just once.

Motorpoint is aiming for £2bn of revenues within a couple of years — 70 per cent online, up from 60 per cent now. Nonetheless, chief executive Mark Carpenter argues purchasers will still want a choice — internet or showroom or a bit of both — and is expanding branches.

Line chart of Share prices rebased in local currency showing Cazoo stalls after IPO

At Cazoo, Chesterman reckons pure digital used-car purchases could top 30 per cent of the UK market — but that’s still plenty for Cazoo if it takes 2 to 3 per cent. He expects Cazoo to go into profit by doubling sales to 100,000 used cars by next year.

That is a tall order. A decade after launch, Carvana, the US online supermarket on which Cazoo is modelled, is barely profitable.

In truth, selling cars, used or new, is extremely competitive.

“This is not an over-earning industry that offers easy pickings for a disruptor,” says Sanjay Vidyarthi of Liberum. “Manufacturers’ overcapacity leads to competition and limited pricing power. The distribution network is complex and fragmented.”

Up to half of used vehicles are sold by franchise dealers tied to manufacturers, often with costly showrooms. Bent on market share, the carmakers flood distributors with new vehicles that must be sold as soon as possible. The resultant discounting trickles down to used cars eating into margins.

Motorpoint has established relationships with manufacturers and fleet companies to source cheap nearly-new cars. Vidyarthi says: “It is a hard model to copy.”

Motorpoint’s share of the nearly-new market is just 4 per cent and its profit margins are still a skinny 2 per cent. But that is twice that of listed franchise dealers, such as Pendragon and Lookers.

At Cazoo, Chesterman’s strategy rests on staying only online and gaining economies of scale. He may be lucky. The pandemic has driven more consumers online while a global chip shortage has stalled motor production, pushing up prices of cars, old and new.

Industry watchers warn it could be temporary. Production will recover, prices fall and margins normalise. Better profitability on used cars is encouraging competition.

Meanwhile, franchise dealers, having to tool up to sell electric vehicles, are investing heavily in virtual forecourts. The competition will intensify as manufacturers seek to offset higher EV production costs by squeezing distributors and dealing directly with punters.

Chesterman says this all helps to forge the online market. Nonetheless, Cazoo’s national network isn’t cheap: last week it raised $630mn in convertible notes to finance expansion.

Liberum’s Vidyarthi reckons Cazoo’s biggest challenge may be securing sufficient cars at good prices. The bigger it grows, the harder it will be.

Cazoo may leap like a hare. But the loss-making company’s shares, trading at a steep two times revenues, are not priced for disappointment even after their decline.

Conversely, profitable Motorpoint trades at a modest nine times forecast earnings. Like the tortoise, it has staying power.

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