What Pendragon's woes tell us about the future of the car business

published 24 October 2017

171024-cars-634 — Traditional car dealerships may be in for harder times

Another day, another nasty profit warning.

Given that it's been a year notable for absence of volatility, we've seen quite a few double-digit disasters in the last few months.

Yesterday it was the turn of Pendragon, one of the UK's biggest car dealers.

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But while the slide in its share price will have left its shareholders smarting, Pendragon's problems are at least as interesting for the rest of us, given what they say about the car industry.

This is about a lot more than Brexit

Pendragon is one of the UK's biggest car dealers. It owns the Evans Halshaw and Stratstone brands. The company now expects full-year underlying profit to come in at around £60m, rather than the £75m expected by analysts. Although revenues rose (strongly in the case of used car sales), gross profits fell by about a fifth during the quarter.

Part of the problem is that sales of new cars as a whole have fallen. That in turn has hit the price of used cars. This is because of "pre-registrations," notes The Times.

That's where dealers register a car, but don't sell it. The tactic is "used by dealers to fulfil contractual obligations or to ensure that they earn bonuses for hitting their targets for selling stock".

Trouble is, if no customer turns up to actually buy the car, it moves from being "new" to "nearly-new". That means it sells at a big discount. So you have an influx of "nearly-new" cars into the used car market, which then drives down prices further down the age range.

The share price tanked by around 18%, despite the company's reassurances that things would pick back up eventually.

So what's going on? There is the usual desperate clutching in the press for reasons for this. You can guarantee a reference to Brexit and the squeeze on "real" wages from inflation rising.

But without dismissing that out of hand (it's true that wages aren't keeping up with inflation), you can't really make sense of this without observing the wild boom in car finance and car sales over the last few years.

Take a look at the registration data from the Society of Motor Manufacturers and Traders. Going back to 2001, then before the financial crisis, the high point for September registrations was actually in 2001, with around 440,000 new cars registered. This figure meandered gradually lower until 2007, when it had fallen to around 420,000.

Then in 2008, amid the financial crisis, new registrations plunged to around 330,000. New registrations remained below 400,000 until a strong recovery in 2013. They then surged to hit fresh record levels in 2015 and 2016. This year's out-turn of 426,000 is in fact in line with the pre-2008 crash norm.

As Gavin Jackson puts it in the FT, "there is increasing evidence that the British car market, which has been fuelled by generous financing arrangements since the 2008 financial crisis, may simply have come to the end of a strong period of growth".

What drove the boom? Two main things. Firstly, there was the availability of cheap credit, which led to the boom in personal contract purchase (PCP) financing, whereby drivers effectively rent cars over a three-year period. Many of those drivers then "rolled over" their contracts into new cars at the end of the period, sustaining demand.

Secondly, there was the PPI compensation bonanza the real people's QE, if you will. The PPI machine really started to pay out in 2013 coinciding with the ramp up in car sales and by March 2017 this year, a full £26bn had been paid out in PPI compensation for mis-selling in total. There are probably still a few drops left to squeeze out of the barrel, but we're getting near to the end now.

That money funded a lot of deposits on new cars, notes The Times. While I've no sympathy for the banks, PPI has proved to be something of a "help-to-buy" subsidy for the car market.

Is the car industry about to start campaigning for green taxes?

So the thing is, if everyone who has a new car has one, and everyone who wants a second-hand car is going to see an influx of them, it's hard to see the car industry avoiding the pains of chronic over-supply.

What does that mean? I can't help but think that it's good news for electric vehicles and other alternatives. And I think car manufacturers have already cottoned onto the idea.

Why are companies falling over themselves to turn all their cars into hybrids? Because they need to push through a fresh upgrade cycle. Now that the diesel scandal has destroyed demand for those cars, the car industry needs to create new markets.

If I was in the car business right now, I'd be lobbying for higher taxes on non-green vehicles, restrictions on where they can drive, and a general tightening on emissions regulations. I might even push for a government-backed green scrappage scheme to fund upgrades from old diesel and petrol motors to electric and hybrid editions.

It's already the biggest growth area registrations of "alternative fuel" vehicles were up by 41% in September on last year, expanding their market share (of new registrations) to 5.3% from just 3.4%.

It'd be a cynical move, but it'd be going with the general trend and campaigning for new, apparently restrictive regulations are a classic method of protecting your sales and profits.

Maybe I'm reaching too far, but if I'm even half-right, it could mean we see the expansion of electric vehicles a lot faster than anyone currently expects. (Also bear in mind that the car manufacturers have to get another upgrade cycle in there before autonomous driving means that we no longer want to own our own vehicles.) We wrote about investing in electric cars in a recent issue of MoneyWeek magazine if you missed the story, you can catch up with it here.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.