The latest report from Zeus, a leading financial services group, provides an updated view on the key themes facing the motor retail sector in 2023.

  • New car volumes improving: 2023 should be a year of volume growth for the new car market due to improving supply of components. The SMMT forecasts (published Feb-23) total new car registrations to rebound 11.2% to 1.794m. New car registration data for the three months to March showed an 18.2% increase year-on-year. We still expect new car margins to be elevated as OEMs favour higher margin models and have an incentive to prevent a glut of supply. The fulfilment of dealer groups’ strong order banks (at high margins) should support sales and profitability for much of the first half of 2023, which should offset some cost pressures.
  • Used car residual values: Used car prices are not showing signs of an impending crash. From 2020-22, there was c. 2.1m lost new car registrations vs. 2010-19 averages and c. 2.5m fewer used car transactions vs. 2014-19 averages. This low supply and unsatisfied demand continues to support used car values. The latest data from Cap HPI showed that trade values of 3-year-old 60k mile cars increased 0.5% in March, the most positive movement for this month since 2012. Average retail prices from Auto Trader have also held up in recent months. Whilst there has been weakness in EV residual values due to oversupply and price cuts from OEMs, we think franchised dealers will continue to earn healthy margins on used cars, albeit below 2021 and early 2022 levels. Auto Trader reported a 9% increase is used car sales in March, based on stock removed from the site, and is seeing faster average times for used cars to sell (26 days in Mar-23 vs. 29 in Mar-19), indicating good market health.
  • UK consumer spending squeeze: High inflation continues to erode consumer spending power. The latest Asda Income tracker showed average weekly household disposable income (after essentials such as housing, food and fuel) declined 12.2% in the year to February. We expect this to weigh on demand somewhat and cause some trading down by consumers, but because cars remain a necessity for many, demand should not disappear. From July, lower energy bills should start to improve spending power when the Ofgem Price Cap is forecast to fall below the Government’s Energy Price Guarantee threshold. Lower wholesale energy costs should also reduce food inflation and services inflation by lowering input costs for businesses. As such, Oxford Economics forecast UK CPI inflation to fall to 3% by the end of 2023. The improving macroeconomic picture has lead the consumer confidence index to increase from the trough of -49 in September 2022 to -36 in March 2023.
  • Higher interest rates: The Bank of England has hiked interest rates at the last eleven Monetary Policy Committee meetings, now standing at 4.25%. A further 25bps increase is expected at the next meeting in May, albeit not a certainty, and the market implied policy rate function on Bloomberg suggests the base rate will be c. 4.3% in one year’s time. Higher rates are increasing interest charges on dealers’ used car stocking loans and any floating rate bank facilities, as well as increasing APRs on consumer financing deals (8.1% average for new cars in Jan-23 vs. 5.1% in Jan-22) which could dampen demand. We expect interest costs to rise for most dealer Groups in 2023 vs. 2022 and for competition to intensify on consumer vehicle financing APRs.
  • Cost pressures: As well as higher interest costs, dealers will continue to face cost pressures from wages and energy. The latest data from the ONS shows that the labour market remains tight, with the number of vacancies close to the number of unemployed people and labour force participation low. Unemployment is not forecast to substantially increase either – Oxford Economics expect unemployment to peak at 4.3% in late 2023 – therefore we expect wage pressure to persist. Wholesale UK gas prices have fallen >80% from the peak in August 2022 following a mild winter and high levels of gas storage across Europe. The forecasts for dealer Group’s may be too bearish on energy costs. Conservative analyst forecasts on cautious guidance may have led to overly bearish estimates.
  • Valuation: 2023 profit forecasts appear cautious compared to 2022, with a step-down in adj. EPS of 1.1% on average, or 11.2% when excluding Inchcape. Even on these cautious forecasts, we think the sector is still undervalued. Pendragon, Vertu and Lookers are all trading on 6-7x P/E. The sector has historically traded through-the-cycle on a P/E range of 8-14x, making the current valuations look exceptionally low. The strong trading through 2021 and 2022 has repaired and strengthened balance sheets for most motor retailers. Property portfolios and cash balances underpin share prices. In particular, Vertu is trading below our estimates of FY23 TNAV per share (64.7p). In our view, there remains significant unrealised value in the quoted franchised motor retailers.