Automotive advertiser and servicer Carsales.Com Ltd (ASX: CAR) has a great business. It remains the dominant automotive portal in Australia, has small investments in promising similar portals overseas, and has a growing stable of parallel businesses that complement the main carsales.com site. It has high profit margins, low fixed costs, and good management.
I have previously been a shareholder and sold as I thought the original business was probably overpriced given its maturity and the sort of growth it was generating. However, a recent look at some Australian Bureau of Statistics (ABS) data also raises some interesting questions about the business’ future prospects. Here’s a graph of new car sales over the past 15 years:
Australians are buying approximately 97,000 new motor vehicles every year, up from 70,000 in 2003. Population growth accounts for some but not all of the increase, with more cars per household, easier access to finance, and cheaper imported cars likely explaining the remaining growth. With Carsales’ earning significant commissions from listing cars at new car dealers, a significant portion of company earnings come directly from new car sales.
In a sense it’s a great business to be in – way better than operating an auto dealership. This way Carsales effectively clips the ticket on cars that get sold through its portal, without having to take on any of the risk of importing the cars. It does, however, mean that the company’s profits fluctuate in line with changes to its market share and the number of new cars being sold.
Outside of increasing its market share or praying Australians buy more new cars, Carsales can also generate profit growth by increasing the price of its ads for car sellers, and developing new features for which it can charge. Carsales also has parallel businesses in finance, vehicle inspection, and tyre sales which are contributing to growth, although they have a much lower margin than the core website business.
Both avenues have contributed to the company’s growth in recent years, although Carsales looks unlikely to extend its market share much further and this means that the impact of other profit-boosting initiatives will be limited. As a result, as much as I like the business, I’m not a buyer of Carsales at current prices.
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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.