Motorpoint Group PLC (LSE: MOTR)

Competitively advantaged UK used-car dealer at ~4x future earnings

Summary

Motorpoint is the UK’s largest independent used car dealer.  Motorpoint’s business model centers around offering unbeatable prices (95% of customers say their prices cannot be beaten).  Because they offer the lowest prices, Motorpoint sells high volumes per site, creating major economies of scale, spreading their fixed costs over more units sold. Their high-volume strategy, coupled with shrewd operational excellence, pushes down their operating expenses as a percentage of revenue to industry-leading levels.  The low cost structure means they can price their cars lower than competitors and still make a decent profit.

To sum it up, Motorpoint’s main advantages create a self-reinforcing cycle:  offer low prices -> achieve higher volumes per store and per employee -> higher volumes lowers unit cost structure -> lower unit cost structure allows them to price below competition.  This powerful competitive advantage, combined with Motorpoint’s asset-light operating strategy, allows them to achieve 50%+ returns on equity, while using no corporate-level debt.

Better yet, Motorpoint’s growth runway is long.  Despite being the UK’s largest used dealer, they only hold a ~3% market share in their niche (0-4 year old cars).  The industry is highly fragmented, with many smaller competitors.  Management announced a plan in July 2021 to double their FY20 revenue and profits over the next three to four years, mainly by opening additional stores.  Management has also stated that they can achieve in the long-term mid-teens market share.

Finally, the valuation is cheap.  Even with their strong competitive advantages, high returns on capital, and long growth runway, Motorpoint currently trades at ~10x current earnings.  And they trade at only ~4-5x management implied earnings at the end of their plan in FY24 (or even lower if you include excess cash generation over that time period).  Although certain risks exist, Motorpoint seems to be significantly undervalued, especially given their highly-profitable future growth potential.

Used Car Industry Dynamics Summary

The used car industry is comprised of a few main types of sellers: small-to-mid sized independent used-only retailers, franchised new car dealers that also sells used vehicles, and large used-car “supermarkets” (e.g., Motorpoint).  Each used car seller competes primarily based on (1) price, (2) location, (3) service, and (4) selection.

Factor #1: Price

Price matters but how does a used car get priced?  As Motorpoint’s CEO has stated, they basically operate in a spread business, applying a margin to their all-in cost to acquire the vehicle.  The cost of a used car primarily consists of: (1) the cost to buy, (2) cost to get the vehicle to the right location and recondition it, (3) “held depreciation”, and (4) indirect overhead costs that are semi-fixed such as marketing, employee costs, and building lease costs.

Buying Costs

Dealers primarily source their cars from consumers, fleets (corporations or leasing companies), and auctions.  Auctions are a costly option as auction fees need to be paid, purchased cars need to be transported to the appropriate site, all while facing price competition from other dealers on every auctioned vehicle. 

Buying from fleets and consumers (or receiving trade-ins) can be much cheaper.  Motorpoint’s pre-pandemic focus was selling 0-2 year old cars purchased mainly from fleets.  Since Motorpoint is the largest used car retailer in the UK, they could provide an easy solution to fleets looking to sell to one buyer, in one simple transaction.  Even better, auto manufacturers typically sell cars to fleets at a discount.  The combination of this discount (that was then passed along in some form when fleets determine a car’s sales price) and Motorpoint’s large buying power allowed them to historically acquire large amounts of cheap inventory.

In the post-pandemic world of shortages, fleets are no longer selling many cars.  Due to this, Motorpoint expanded its ability to buy from consumers, now allowing people to sell their car to Motorpoint, even if they are not buying from Motorpoint.  In FY22, they sourced 18% of their retail units sold from consumers (up from 6% in prior year).  Motorpoint has also adjusted to the lack of inventory by beginning to sell 3-4 year old cars, as opposed to their former 0-2 year old niche.  Previously they would dispose of any car older than two years via Motorpoint’s auction business, Auction4Cars.  Now they retain these vehicles, allowing them to sell them at higher retail prices.

Depreciation Costs

The second component of a used car’s unit cost is “held depreciation”, which represents the amount of depreciation occurring prior to sale.  Motorpoint exceeds the competition here as well by achieving some of the highest inventory turns in the industry.  Historically, they turned over their inventory ~9x per year, with most years leading their UK used car supermarket peers in this metric.  They are also still competitive on inventory turns compared to new car franchised dealers, despite franchised dealers sourcing more of their vehicles on-site via lease returns and new car buyer’s trade-ins. 

Since Motorpoint holds their inventory for minimal time they also incur minimal depreciation.  This performance is driven by management’s efficiency at funneling purchased cars to the right location and then employees are equally effective at selling these cars.  To oversimplify, it’s doing all the little things correctly and efficiently, each and every day. Obviously, it also helps move cars when you are the price-leader of the industry (… with the most satisfied workforce in the industry - discussed later).

However, during the recent supply shortages, holding used cars for longer has recently been a good action for dealers, as prices appreciated instead of depreciated.  But, this dynamic has recently changed.  Motorpoint’s CEO stated in mid-May 2022: “Sure, prices are around 30% higher than they were a year ago but prices have plateaued and are beginning to ease off. Additionally, for the first time since COVID, we’re seeing normal levels of depreciation returning, with stock typically losing between 1.5% and 2% of its value per month.”

Indirect Overhead Costs

The final component of unit cost, indirect overhead is really Motorpoint’s “secret sauce”.  Since Motorpoint does such volume per site they can spread their fixed and semi-fixed costs over many units sold, lowering their unit cost structure.  The indirect overhead of operating a used car retailer contains three main semi-fixed costs: (1) site lease/ownership costs, (2) employee compensation, and (3) marketing. 

Besides employee commissions, none of these other costs increase proportionally as sales increase.  For example, just because sales double, does not mean lease costs double.  Motorpoint achieves revenue per location of £85mm+ (mature stores are likely much higher).  Whereas the average public UK franchised dealer generates £30mm+ per site (this includes their service and new car sales as well), and the largest UK used car supermarkets generate a similar amount to Motorpoint in revenue per site.  Also, franchised dealers need to abide by auto manufacturers requirements, which usually means locating their dealerships in higher cost locations and updating/renovating their sites when requested. Overall, this means Motorpoint, and the other large used-car supermarkets, are able to leverage their occupancy costs with more revenue per site, while also operating less expensive sites in less expensive areas than franchised dealers.

Employee costs also do not increase directly proportionally with sales.  A dealer may need more employees if sales increase, but most employees are not working at 100% capacity - they can always take on additional customers per day.  This leveraging of employee expenses is where Motorpoint really exceeds peers.  Despite paying the same average amount per employee as their competitors, Motorpoint has significantly lower compensation expenses as a percentage of their revenue.  On this metric, Motorpoint has averaged ~3% of revenue historically, whereas both UK franchised dealers and UK used car supermarkets average 6-7%.  According to management, this is achieved via their higher inventory turnover and from their highly-productive employees.  Motorpoint’s operational efficiency is truly amazing.

To sum it all up, Motorpoint has lower unit costs than the competition by being well-positioned to buy from the cheapest sources, incurring low depreciation per unit, and with very low per unit indirect overhead costs.  These lower unit cost advantages, show up in Motorpoint’s financials with its industry-leading operating expenses as a percentage of revenue (5-6% for Motorpoint versus 8-10% for competitors).   This allows them to price below the competition, operating at gross margins levels not profitable for many competitors.

Factor #2: Location

Currently Motorpoint operates 17 locations throughout the U.K.  Pre-pandemic Motorpoint was very conservative with their new store strategy, targeting one new store per year.  However, in July 2021, they announced a plan to significantly increase the number of stores over the following 3-4 years.  Management’s plan is to open 12 new stores that will be smaller than their existing sites, serving mainly as sales and collection centers. 

Management’s thinking is simply that location matters significantly.  According to Motorpoint’s FY22 call, their market share to customers greater than 30 minutes away from a store is <1%.  But, their market share with customers less than 30 minutes away is 7.7%.  This dynamic is reinforced by an analysis by the U.K.’s CarWow in 2017 revealing two main facts: 

1. average car customer from London or Northwest England, travels 32-33 miles to purchase their car.  In Northeast England this figure increases to 62 miles and for Scotland it increases to 151 miles, and 

2. as the price of the car decreases, a customer’s willingness to travel also decreases, and vice versa

With (1) Motorpoint selling mainly cars on the cheaper end of the scale, and (2) most of the U.K. population, in the London or Northwest England area, Motorpoint’s need to place branches close to customers is crucial.

More importantly, this dynamic also reveals that the threat of Motorpoint cannibalizing their current store’s sales with new stores, is not much of a threat at all.  The lack of almost any market share in markets greater than 30 minutes away, means if Motorpoint continues to open stores at the appropriate distances from existing sites, nearly all incremental sales should come from new customers.

Growth potential for Motorpoint is large via both store count growth and additional market share growth at their younger stores.  Management has stated previously that they can eventually achieve mid-teens market share.  With their pre-2013 opened store cohort operating at ~10% market share, even these stores have significant room to grow if management’s targets are correct.

Factor #3: Service

Badly reconditioned cars or overly pushy salesman using less than ethical sales tactics can easily turn-off a customer from making a purchase at a specific dealer in the future (or recommending that dealer).  Fortunately, Motorpoint exceeds on service and the data proves it.  They have a net promoter score of 84.  This ranks above the net promoter score of many top global brands and more importantly, it is about double the average score of the automotive industry.  For an industry not known for its loving customers, this score is remarkable.

Motorpoint’s happy employees undoubtedly help increase customer satisfaction.  After all, happy employees are more likely to delight the customer than a disgruntled or uninterested employee.  While every company aims to please their employees, Motorpoint seems truly focused on achieving this goal.  Motorpoint is ranked as #1 within the automotive sector, in the UK’s Sunday Times Best Large Company to Work survey.

Factor #4: Selection/Choice

Most UK consumers begin their car buying journey by first visiting AutoTrader’s website.  AutoTrader has 90% prompted brand awareness among consumers and is the dominant car buying research platform in the UK.  Among all car buying websites, UK consumers spend 75% of their car research minutes on the site.  This compares to 9-10% of “minutes share” for their #2 competitor.  Simply put, UK consumers value AutoTrader as the first and potentially final research point for finding the vehicles they will either buy or visit.

Motorpoint and most other dealers pay a monthly subscription to AutoTrader to list cars on their website.  The importance of this is AutoTrader’s platform has effectively created the ultimate large UK “dealership” with great breadth and depth of car variety.  Consumers know they can visit the website and find all types of cars and compare prices in the process.  Motorpoint, as the largest UK used car dealer, will obviously be able to list a much larger inventory than almost all other competitors.  But better yet, due to Motorpoint’s unbeatable prices, UK consumer comparison shopping on AutoTrader is to Motorpoint’s benefit.  Even AutoTrader stated in a recent a May 2022 AutoTrader presentation that: “Motorpoint has consistently more 'well priced' stock compared to the marketplace, and this trend is growing.”

It should also be noted on “Selection/Choice”, that people always have the choice of buying a new vehicle instead of used.  In historical recessions, used car sales usually decline much less than new car sales.  For example, during the 2008-2009 Financial Crisis, Motorpoint’s revenue declined less than 8%, from highest point to lowest point, showing the resilience even with the UK unemployment rate reaching ~8% (compared to -18% decline in new car volumes in the UK).  When times get tough, people (1) buy less, (2) buy cheaper, and/or (3) are more concerned with buying better “value”.  Although people may choose to buy less in a recession, with Motorpoint being the low-cost UK used car dealer, Motorpoint will excel when people choose to buy cheaper and are looking to get the most value for their money.

Valuation

Motorpoint made ~£17mm in earnings during FY22 (year end March 2022).  During the year, they opened three new sites, two of which opened in the final two months of the fiscal year.  Which means Motorpoint incurred operating expenses to open these sites, but only received one or two months of revenue.  And the revenue of Motorpoint’s stores ramp significantly in subsequent years.  Motorpoint also spent marketing dollars of ~£19mm in FY22, versus ~£7mm in prior years.  The point of all this is that Motorpoint’s earnings include heightened investment expenses as they execute on the FY24 growth plans. Without adjusting earnings for any of the previously mentioned items, Motorpoint trades at ~10x earnings on their ~£170mm market valuation.

And frankly, the current earnings multiple is a bit irrelevant, due to the amount of growth Motorpoint should experience in the next few years.  Let’s focus on management’s FY24 projections (see graphic below).  If Motorpoint achieves their targeted ~£2bn of revenue at a midpoint 2.5% pre-tax margin, then that implies after-tax earnings of ~£37.5mm (meaning, they trade at 4.5x earnings).  But, Motorpoint should also generate distributable free cash flow of £10-£15mm per year until the end of management’s FY24 plan, implying they are trading for ~4x FY24 estimated earnings, when including excess cash generation.

The obvious question then is can management achieve their projections on revenue and margins?  With the 12 new stores, Motorpoint will operate 26 total stores by the end of the plan.  Last year Motorpoint generated £85mm per store on their average store count.  Mature stores likely generate £100mm+ in revenue currently, however the newer stores are a smaller format and will likely generate smaller volumes.  Even if you assume no additional increase in revenue per store and assume that the 26 sites each generate £85mm, that implies £2.2bn of total revenue.

As stated previously, the business is essentially a spread business where a margin is applied to the cost of the vehicle, creating stable margins.  Motorpoint has operated at ~8% gross margins historically and overhead plus interest expenses have been in the 5.5%-6.5% range.  Using these figures, implies 1.5%-2.5% pre-tax margins, which is a slightly lower range than management’s forecast.  On £2.2bn of revenue, these levels of margins would generate after-tax earnings of ~£25mm-£40mm.  On Motorpoint’s current ~£170mm valuation (~£195p per share), these earnings imply a 4x-7x multiple, before including excess free cash flow generated.

However, there is reason to believe that a fully mature Motorpoint operates at the lower end of the 5.5%-6.5% overhead+interest expense range.  The only year on record where Motorpoint did not open a new store was FY19.  In that year, overhead+interest was ~5.4% of revenue.  Yet, FY19 still included the dampened results of non-mature stores prior years, just not the opening costs of a new store.  So, the expense leverage could be even greater than FY19 displayed. 

You can run the analysis out further to, say, five years, with assumptions of 30 stores, and with existing sites continue to mature up the mid-teens market share management has cited as achievable.  These numbers are almost absurdly attractive compared to the current valuation and are not required to generate a more than adequate return.  Whether they end up trading at 15x earnings or 20x in five years, Motorpoint should increase multiples above its current valuation, assuming it can navigate a few risks.

Risks

The largest risk to Motorpoint is a competitor manages to steal volume from them, which would “un-wind” some of the high-volume operating leverage that is so important to Motorpoint’s business.  I view this as unlikely mainly due to: (1) historically difficult industry, (2) very fragmented UK used car market and (3) recent changes in valuation and strategy of Motorpoint’s aggressive online competitors.

The ability to achieve a lower cost structure depends on utilizing a high-volume strategy.  And this high-volume does not appear overnight.  As shown in the market share graphic above, market share grows slowly year-by-year by delighting customers and running an efficient operation.  This is no easy task – just look at the U.S. used car market.  There is a reason why the only real large, profitable, used car dealer is Carmax.  It is an industry with a large graveyard full of many failures.  Operating on slim margins requires incredible operational discipline, heavily aided by a superior CEO (more on that below).

Second, the UK used car market is extremely fragmented, filled with many smaller, less-efficient operators.  This is not a situation where Motorpoint holds 50% market share and a competitor’s growth only comes at the expense of Motorpoint’s share.  If anything, more efficient operators should steal share away from the smaller, less-efficient operators that cannot offer the same low prices.  As long as AutoTrader continues to be the website most UK car consumers use to find their next car, then Motorpoint and the other efficient operators should have a place in the UK’s used car market.

To continue that last point, the one large risk is if AutoTrader is displaced as the “go to” site by a competitor’s website.  This is effectively what online competitors Cazoo and Cinch were attempting to do before recent events slowed them down significantly.  If UK consumers suddenly switch to thinking “Cazoo” instead of “AutoTrader” when they want to search for a used car, then Motorpoint will be left out, since Cazoo only sells Cazoo vehicles.  This obviously assumes that Cazoo/Cinch achieve such a size that they can offer the same breadth and depth of used cars as AutoTrader provides, otherwise AutoTrader will always be more useful to consumers.  This is no easy task and has become even more difficult for them. 

As interest rates began to rise this year, shareholders and bondholders of Cazoo/Cinch (and Carvana in the U.S.), became unwilling to tolerate never-ending losses for the sake of rapid growth.  Due to this, Cazoo/Cinch recently changed strategies from a very aggressive growth stance to seeking slower, profitable growth.  They are spending less on marketing their brand, while also presumably being forced to price their inventory more rationally to achieve future profitability.  This means they are forced to grow slower if they want to survive, which means the chance of one of them displacing AutoTrader has becoming an even smaller probability now.  Nothing is guaranteed, but I like Motorpoint’s odds of succeeding, especially given the low expectations implied by their current valuation.

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Other Factors for Consideration

Management

The CEO, Mark Carpenter, owns 10% of the company.  Carpenter was the former CFO at Sytner, the largest U.K. auto dealership.  He brings an analytical, data-driven approach, which shines through in their publicly-released financials, showing various important metrics that other companies might not bother to measure.  The company has historically operated very conservatively, considering they have not carried any company-level debt, and, pre-pandemic, opened only one new store per year.

Carpenter receives a salary of £350k and was paid £978k in total for FY22.  Much of his non-salary compensation is paid in stock or is cash incentive pay.  Unlike most CEOs, his salary is dwarfed by the ~£17mm of stock he owns in Motorpoint.  He is highly-aligned with shareholders given this level of stock ownership and his current incentive pay structure (focused on broad mix of growth, profits, customer/employee satisfaction).  Given his shareholder-alignment, it is no surprise that Motorpoint has shown the ability to return cash to shareholders.  Before the pandemic, they paid a dividend and repurchased nearly 10% of their stock from 2018 to 2020 at intelligent prices.  And, at their recent Annual Meeting, shareholders approved a stock repurchase plan for another 10% of shares outstanding.  Given the compelling economics of this business, capital returns should restart soon.

Business Economics

Despite operating on small margins, Motorpoint’s high inventory turnover and asset-light real estate strategy mean they still achieve a return on average assets of 8-9% in a typical year.  Unlike many car dealers, Motorpoint seeks to lease all their properties, conducting a sale-leaseback shortly after opening each store.  According to Motorpoint’s management, the leases have been structured in an inflation-friendly manner, with price increases capped at 1-3%.

Leasing real estate reduces the capital intensity of the business and allows Motorpoint to redeploy that capital into building new stores.  Due to the minimal investment required for their floor-planned inventory, leased fixed assets, and small receivables, the resulting returns on average equity are 50%+. 

Due to the high ROE’s, the business economics to shareholders are very compelling.  Even with Motorpoint investing ~£2mm of equity per store, in a year where they build three new stores for ~£6mm total, they will still have ample free cash flow to distribute to shareholders.  Thus, the earlier mentioned conservative target that they should be able to return £10-£15mm of free cash flow annually over the next few years.  Over the course of the next five years, distributable free cash flow should ramp significantly, as they complete their new store growth plan.

Auction4Cars

Motorpoint also operates an auction site for cars it does not plan to retail.  Due to Motorpoint’s strict pre-pandemic criteria of 0-2 year old cars and <15k miles, many trade-ins did not fit their desired profile.  Instead of paying someone else to auction the cars for them, Motorpoint built Auction4Cars to dispose of these vehicles. 

Motorpoint decided to change the business model to now allow third-party sellers.  They have also decided to utilize their low-price retail strategy within this auction business.  According to Auction4Cars, competitor’s auction fees can be 800%+ higher than Motorpoint. 

When I asked management how they were able to achieve the lower fees, they confirmed that it was a combination of a lower cost structure and the competition pricing unusually high historically.  Although they seem to not want to disclose too information on Auction4Cars advantages, based on Motorpoint’s current valuation, you are essentially paying nothing for the future growth potential of their auction business.  Given management’s remarkable operating ability, I would not put it past them to turn the auction business into a much larger profit engine over time.

Disclosure: I currently hold shares of Motorpoint. I may buy more or sell my position at any time. Please do your own due diligence before making any investment. None of my posts are investment advice.