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There’s a temptation, whenever you come across a company that may not have a long-term future as one technological revolution succeeds another, to think that it has no value at all. Naturally this is not the case for a business that right now is profitable and has assets, but the perception can weigh on the share price – and thus give rise to opportunities for more alert investors.
Questor is thinking of Lookers, the car dealership, which faces disruption on a number of fronts. One is that carmakers are changing the way they interact with customers as they start to focus on electric vehicles – VW and Volvo, for example, have said they will sell electric cars directly and relegate dealers to the status of service centres. Another is that the used car market is beginning to be shaken up.
In December last year this column covered Carvana, whose impressive online used car business in America focuses heavily on giving customers a smooth ride through the buying process. But digital disrupters are beginning to pop up on this side of the Atlantic too.
One is Cazoo, run by Alex Chesterman, the founder of Zoopla. Cazoo simplifies the process of buying online by replacing test drives with a guarantee that you can get your money back after seven days if you don’t like the car and promises that the advertised price is the best possible. Cazoo has forecast an astonishing annualised rate of sales growth of 421pc between 2021 and 2023.
No doubt more disrupters will appear, either from the efforts of clever, motivated individuals such as Chesterman or from digital incumbents such as Google.
Let’s focus on the worst reasonable outcome for Lookers if digital rivals do in fact flourish so quickly that its business fails to survive long into the next decade. Analysts at Peel Hunt, the broker, have run the numbers.
There are many ways to value a business but in this column’s view the gold standard goes by the ungainly name of “discounted cash flow”. It is based on the simple idea that a company’s worth now is equal to all the money you will get back from it in future, in the form of dividends and its eventual “residual” value when you sell, but with all those future returns of cash to you “discounted” according to how far into the future they will arrive.
Complications arise over the “discount rate” to use and the residual value, although Peel Hunt eliminated the latter issue by simply assuming for the sake of its modelling that Lookers would have no value in 10 years’ time.
It said: “A fairly conservative 10-year discounted cash flow calculation with zero terminal value can justify 20pc upside to the current share price.”
It’s quite a thought: you buy a stake in a business that will be dead in 10 years and still make a profit of 20pc, although we must acknowledge that the share price has risen since the broker published its analysis from 64p to 69.8p at Friday’s close. If Peel Hunt’s discounted cash flow valuation doesn’t convince, it added that the value of Lookers’ property of more than 80p a share was also more than the prevailing share price.
Aside from outside pressures, Lookers has endured a torrid few years – an investigation by the regulator into sales practices, suspected fraud, a string of boardroom changes, delays in publishing results and a consequent suspension in trading in its shares. It has also cut thousands of jobs and closed some sites. As a result its shares have performed far worse than those of rivals Vertu and Inchcape.
But if we forget for a moment the perils of disruption later in the decade, the more immediate future looks a lot brighter than the recent past.
There finally seems to be some stability in the boardroom and trading is recovering: Peel Hunt and Numis, another broker, have both forecast big jumps in profits for the next couple of years – to about £40m pre-tax for 2021 from just £4.2m in 2019 and then £51.8m (Peel Hunt) or £45m (Numis) for 2022 (“adjusted” figures). Results for 2020, due on Tuesday, will include profits of about £10m, the company has said already.
Sums such as £40m or £50m are substantial indeed against a market value of just £273m. A few years like that and you will get your money back whatever happens in the longer term. Whichever way you look at it, this business seems undervalued.
Questor says: buy
Share price at close: 69.8p
Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 5am.