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Downgrade: AP Eagers Ltd updates the market

Just yesterday I highlighted the drop in new car sales Australia-wide. I had Carsales.Com Ltd (ASX: CAR) on my mind at the time, but if I’d been a little more forward-thinking I would also have highlighted the possible implications of car dealerships like AP Eagers Ltd (ASX: APE).

AP Eagers this morning released its annual general meeting to the market, and updated its guidance for the first half of the year. The impact on company results as a result of lower vehicle sales has been fairly serious, with national sales down 2.8% in January-April, and Queensland sales falling 5.9% during the same period. There were declines in each of the private, business, and government purchaser categories.

AP Eagers completes 45% of its sales in Queensland so the impact has been material, and the company informed the market that first half profit would fall by approximately 7% to 9% compared to the first half last year. At this point it is anticipated that the dividend will be maintained at a constant level. Management has commenced a company-wide review of costs with the goal of making the business more efficient.

Elsewhere in the presentation, there was also an update on the company’s Carzoos project, whose website is worth a look by all shareholders.

Is AP Eagers cheap?

The company appears to be a well-managed business, with a great portfolio of dealerships in good locations Australia-wide. It’s paid a dividend every year since 1957 and has a sound balance sheet, so the chances of it going bankrupt appear remote.

However, there’s no escaping that demand for new cars and car finance are driven by the wealth (or perceived wealth) of the nation and we appear to be sailing in to some tougher times. New car sales haven’t had a serious dip since the GFC so I would recommend investors read the company’s report from 2009 for some context.

Car sales dived 7.4% in 2009, and would have dived a further 8.5% if not for the government fiscal stimulus. AP Eagers did experience wider profit margins due to holding less inventory, however. This year we’ve seen a 7% to 9% drop in the company’s first half profit on the back of some relatively modest declines in new vehicle sales. In the event of a major economic shock, AP Eagers business will fare much worse.

With that said, the business is unlikely to go broke and its ability to sell used cars will be an important protective factor in these circumstances. The company is also well positioned for an eventual economic recovery. I think long-term investors could consider buying AP Eagers shares at today’s prices, but only if they knew they could take a ‘through the cycle’ look at the business, and run the risk of possible heavy falls in the share price along the way.

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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.

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