Why I think Carsales.Com Ltd could be a sell at $15

The Carsales.Com Ltd (ASX: CAR) share price has risen 26% to $14.34 in the past 12 months, giving the company a market capitalisation of around $3.5 billion.

It’s a lofty valuation for a company that earned just $109 million in net profit after tax (NPAT) last year, pricing the company at around 31x earnings.

Revenue grew 8% during year, while earnings before interest, tax, depreciation and amortisation (EBITDA) grew 4%. Reported profits were basically flat due to losses recorded on the group’s stake in iCar Asia Ltd (ASX: ICQ).

There are two primary reasons I think the company could be a sell:

  • Its valuation. 31x earnings is lofty for a company that is a) primarily growing through price increases and b) not growing all that fast. Plus, at least some of the growth came from lower finance costs due to lower debt.
  • While Carsales has strong network effects, several competitors like Facebook and Gumtree also have strong offerings. These recently forced Carsales to introduce free leads for cars below $4,000. The introduction of free listings did lead to an increase in inventory, which suggests that Carsales is still a prime platform for selling your vehicle. However, it does show how the company’s pricing power could be partially undermined by competitors.

It’s not that I think Facebook or Gumtree are going to destroy Carsales, nor do I think the company is likely to be a huge failure. It’s just that, on the balance of probabilities, Carsales already has a significant amount of optimism priced in – perhaps too much, given the sources of its growth and strengthening competition.

Much of the company’s growth in future could come from lower-margin and more competitive tyre sales and car inspection services. Credit Suisse also thinks Carsales could be a sell.  I previously sold my Carsales shares at around $12-$13.

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Motley Fool contributor Sean O'Neill has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Limited. 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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