Gamble of the week: A car dealer with growth potential

Britain’s car market is booming. New car registrations grew by more than 8% in April – the 26th consecutive month of growth. New car sales are forecast to top the pre-recession peak of 2.4 million this year.

That’s good news for the likes of this Aim-listed company, the sixth biggest car dealer in the UK. But how long can the good times last? The market for new cars in Britain looks increasingly like a debt-fuelled boom, with nearly four out of five cars bought on credit.

Economies across Europe have been weak and this means that car makers have to find a home for their output to keep their factories busy. UK consumers have snapped up the tempting cheap finance deals they are offering. In fact, it seems that many of them are renting cars for three years rather than buying them outright.

This has been good for the car dealers. But what happens when interest rates rise and car finance becomes more expensive? Also there’s a risk that the price of used cars could fall, which could be a problem when there are lots of three-year-old ones to sell.

Surely the easy money has been made in the shares of car dealers? Maybe, but the investment case for Vertu Motors (Aim: VTU) isn’t just linked to selling more cars. Selling new cars isn’t very profitable. You have to sell lots to cover all the costs.

There’s a lot more profit to be made after the car has been sold, from servicing and spare parts. This accounts for less than 10% of Vertu’s sales at the moment, but has scope to increase given the growth in the number of new cars out there.

Vertu Motors share price chartVertu was created to buy up underperforming dealerships and make them more profitable. In the seven years it has been in business, it has grown to 108 dealerships.

After starting out with the big volume brands, such as Ford and Vauxhall, it is now moving more upmarket with Volkswagen, Land Rover and Jaguar dealerships. By building up scale with the manufacturers, it can buy better and make more money.

Vertu has said that it will keep on buying dealerships. With many of the ones already bought yet to fully mature, this should continue to be a good source of profit growth. And with £31m of cash on its balance sheet, it is not short of money, so it is perfectly able to do this.

Combine this with more aftermarket sales and there is scope for Vertu’s wafer-thin profit margins – of just over 1% – to increase. The shares are quite risky, given the dependence of new sales on debt; but trading on just over 12 times earnings, they look worth a punt.

Verdict: buy at 57p