Once in a while, when I come across an interesting investing idea that is not actionable for Eden, I’ll happily share it with the readers of this blog. I came across Cambria Auto a few months ago and unfortunately, the trading in the stock is too thin and doest not enable us to build a position there. Before we begin, I would like to remind everybody that this is not an investment advice and each one should do his/her own research. Some parts or even all of my analysis might be wrong so I urge you to either do your own due diligence or just to read this as an educational article. Your comments, of course, are most welcome.
Cambria, or in its full name “Cambria Automobile Plc”, is a small UK car dealership group. The company’s website and annual reports contain a lot of useful information about it and I urge you to do some reading to learn more about the company.
Income and Profit Sources
Cambria is a simple business that has three revenue streams: new cars (45.5% of revenue), used cars (45% of revenue) and aftersales that include maintenance, accessories and repair services (11.6% of revenue). If you wonder why those numbers add up to more than 100% then you have a sharp eye 🙂 and on a more serious note, it is because there are some internal sales among the segments. While aftersales makes only 11.6% of the revenue, this stream produces 40% of the company’s gross profit.
Cambria sells quite a few brands that range from premium (Jaguar, Aston Martin etc.) to volume (Ford, Mazda etc.). So Cambria gets stock from car manufacturers and from car owners who want to upgrade/sell their car and then sells/resells those cars into the market. The margins in this business are around 9% for used cars and around 6% for new cars.
Now that we know what the company is doing and how it generates revenue, it is a good time to take a step back and look at the market in which it operates.
The UK has about 4900 franchised dealerships. The top-10 dealers make 23% of the market, dealers that are ranked 11-20 make 7% of the market, 21-30 make 9% of the market and the others make for the other 61%. As you can see, this is a pretty fragmented market. Cambria is at the ~20 position.
The current market volume for new car registrations runs at 2.7m units per year. If we go back to 2002 there were 2.56m registrations and that was the mid-cycle, which usually lasts for three years. Due to the financial crisis, car sales were way below average from 2008 till 2013 and these sales were done to a market that wasn’t oversupplied to begin with, so currently the market sees some pent-up demand that materializes in terms of demand for new cars. You can see some statistics about the market and get a nice historical perspective through the official data on this website.
There were a few changes to the car market in recent years. Up until four years ago less than half the people who purchased a new card used financing. Now this number is over 80% and growing. People now pay a small purchase price deposit and buy the car on a 36-month agreement and then they can upgrade their car after 27 months. This creates less cyclically in the new car market.
The aftersales market in the UK is not that volatile and less exposed to the cycle. Obviously, the more cars the company sells, the more cross sell opportunities it gets to sell maintenance, repair and other services.
Another positive change in the market is that car makers are looking to have exclusive distributors in designated areas so once Cambria takes over a certain territory, it will be the exclusive dealer for certain brands in this territory.
So, we have a fragmented market that is the high part of the cycle for the new car market and we know that we should have 2-3 more years with more-than-average demand to make up for the lackluster demand during the years after the financial crisis. With that, we can move on to Cambria’s strategy.
There are quite a few car dealership businesses listed in the UK market, so why did I pick Cambria? First, it is cheap, but we will get to that later. Price is very important but there are a lot of other things to like about the Cambria story. The main reason is that this business has many attributes that usually lead to satisfactory investment results: a compelling strategy, fantastic execution and high quality people who run the show and have skin in the game.
Cambria is a relatively young company, it was started in 2005 by the current CEO, Mark Lavery, a car dealership industry veteran, with private equity backing. It did the first acquisition in 2006 and got listed on the AIM exchange in 2010. Mr. Lavery holds 40% of the company and is an owner-operator, a dynamic that I particularly like.
Cambria runs a roll-up strategy, it buys dealerships at very opportunistic prices, improves them and gets them on the Cambria system, which we will soon explore.
Fortunately, the company started trading in the very shortly before the financial crisis hit in full force. Why fortunately you may ask. Because it gave us an opportunity to see how Mr. Lavery performed under an extremely tough market conditions. As you can imagine, he rose up to the occasion and scooped up many dealerships practically for free, look at the relevant part of the summary that I did for the company’s acquisition history:
As you can see, apart from the big Summit acquisition in December 2007, all other businesses came almost for free. Isn’t it amazing?
Since then, all those businesses were turned around and became profitable as a part of the Cambria system. In the following years the company did more acquisitions in both the volume and luxury segments. On a chat that we had with the CEO we asked him how does he expect the current Cambria to behave in a downturn and he gave us a frank answer that both used and new cars sales suffer a lot during a downturn. However, in a downturn there are many attractive M&A opportunities and also, the luxury segment (mainly Jaguar and Land Rover for Cambria) usually recovers much faster than the general market. So a negative cycle won’t necessarily mean bad news for the company.
Cambria doesn’t buy businesses that are offered on the market and could be the subject of a bidding war. What usually happens is that the OEM approaches Cambria and asks it to buy underperforming dealerships and thanks to Cambria’s good track record in improving operations, they get a decent amount of offers of that sort. I analyzed M&A deals of competitors and in all cases the multiples that competitors paid were much higher.
An example for Cambria’s excellent deal-making skills can be seen in the latest acquisition. It paid £2.1m for Jaguar and Land Rover dealerships. These dealerships made £44m in revenue in 2015 and earned a pre-tax profit of £0.7m. So Cambria paid 3 times the pre-tax earnings, that’s cheap by any standard, especially considering that once dealerships become a part of Cambria, their performance tends to improve. This is one of many examples of how Cambria creates value through smart acquisitions and fantastic capital allocation decisions by the owner. This year’s sales will come at about £600m and Cambria has a goal for the future to reach to £1bn in sales with 2% pre-tax margin. By the way, the growth that Cambria generated over the years happened while keeping the share count constant at 100m and the latest balance sheet shows no net debt.
So we have an owner-operator, very good execution and capital allocation, industry-leading ROE of 20% and what seems like a very compelling story. It begs the question of how does the company do that?
Cambria runs a Velocity Trading system for used cars and it does so very well. I can write many words about it but the following slide says it best:
The slide shows how Cambria, by turning its stock faster than the industry’s average, generates high ROI, which later translates into an industry leading ROE. Cambria has a sophisticated system that it uses to track each car on the stock and check how long has it been in stock, pulls data about resale prices from databases and optimizes the offering to the market. We were surprised to find out that only 7% of the second-hand dealerships use a digital source for second-hand car pricing because there is a behavioral resistance by old-school industry players to go digital. Cambria, however, embraces the trend, increases transparency and works hard to offer the best deal to the customer by managing the business well, keeping costs low and turning the inventory fast. Cambria uses these systems to decide how much to pay for a second-hand car based on the desirability of that car in that particular area, what price will they have to sell it to stay competitive and so on.
By the way, from my experience, these are very common symptoms of businesses that are run by an owner-operator who lives and breathes the business and does everything to get the most out of his assets.
Simply put, Cambria buys underperforming dealerships in a highly fragmented industry and gets those dealerships under its tight management and control, improves their performance, generates more cash and goes out to buy more dealership.
This section is going to be very brief. I expect Cambria to make a net profit of £8.2m this year (Cambria’s year ends in August). On a market cap of £68.7m (at the time I wrote this piece) that gives us PE ratio of 8.4. In my opinion this is pretty cheap for a growing business, with an excellent management team and long runway for growth in a fragmented industry. The management seems to be on track to reach the goal of £1bn in sales and 2% pre-tax margin and when it does, even if it will take 5 more years, the company will be worth many multiples of what it is worth today. While at the current price you certainly don’t pay for that rosy scenario, there’s no reason why this talented management team can’t achieve it.
The company fell by almost 20% in the days after the Brexit vote and has only partially recovered. I think the post-Brexit price was very compelling.
Finally, the market will most likely make the shares go down should an economic slowdown take place but I think that a soft economy will enable Cambria to scale up much faster and on the cheap so while there might be some price volatility involved, I don’t think that the business will see any negative impact in the long-term.
I wish that this good story came with no risks, but it doesn’t. Here are the main risks that I see:
- Brexit-led recession in the UK
- As financing plans are more common, banking liquidity crisis can have very negative impact on financing-driven demand for cars
- M&A execution and/or paying too much for acquisitions
- Key person risk, Mark Lavery
- Takeunder: while Mark Lavery seems like a very shareholder friendly CEO if a bear market takes the company’s shares to very low levels, it might be tempting for him to buy the other 60% of the company on the cheap. I think the risk for that is very low because it is better for an M&A driven company to have access to the capital markets.
Too bad that Cambria is so small and doesn’t have much public float AND on top of all that it is traded at the AIM where trading volumes are usually thin. I really like the core elements of the story here and I find the 8.4 times earnings valuation to be very attractive, especially for such a business that can grow earnings at a 20%-a-year clip for quite some years into the future.
I’m open to hear your thoughts about this investment idea, any comment is welcome, especially if you find any flaws in the analysis.