Car sales were improving in June, but in July when the first announcements regarding the possible changes to the Fringe Benefit Tax came out, the market quickly saw the ramifications of the proposal, and companies like McMillan Shakespeare (ASX: MMS) went immediately down in share price.
Companies and government agencies use salary packaging and fleet maintenance to provide vehicles for employees, so reductions in the FBT would mean less individual and fleet purchases. Business for salary packaging companies is starting to return to normal after the proposed legislative changes were scrapped as promised by the new government.
Listed auto dealership companies like Automotive Holdings (ASX: AHE) and AP Eagers (ASX: APE) are two companies that gave a sigh of relief. Although there was a 3.0% decrease in the number or cars sold when compared to this time last year, there was a 2.6% rise for the year to date.
Apart from direct sales, after-market parts companies were also pulled down by the market with a knock-on effect. Since July ARB Corporation (ASX: ARP) has trended down in share price, but this was also attributable to lower vehicle use in the mining industry as miners cut back on costs.
If car sales recover and even get a boost from a general upturn in the economy, which of these will give the best returns for shareholders?
McMillan Shakespeare has had net profit margins in the high teens and return of equity a little above 30% for the last three years, so think of this one-off share price drop as an opportunity to get in at a fairly decent price-earnings (PE) ratio of 16 currently.
For AP Eagers and Automotive Holdings, returns on equity are around 11%-12%, but net profit margins are 2.1% and 1.5% respectively, which means you have to see a lot of earnings growth to make an investment stack up in a very mature auto sales industry. Of these two, AP Eagers wins out because it has grown it after tax earnings by an average 14% annually for the past five years, whereas Automotive Holdings only racked up a five-year average of 4.65%.
ARB Corporation has consistently had net profit margins of around 14%, but earnings growth has been slowing. A lot of the vehicle parts and accessories are more discretionary spending, so it benefits when consumers have more disposable income. It has no debt, and is financially sturdy. It's at the bottom of a new trading range, yet its 20 PE isn't matching up well with the forecasted 9% annual earnings per share growth over the next two years.
Foolish takeaway
In a diversified portfolio, you would only want one of these to cover the car industry, so I would be going for McMillan Shakespeare. As much as I like off-roading and the smell of new cars, growing my profits would be still at the top of my list.
