Looking under the hood to explain 25% increase in Carsales horsepower

Perception can be powerful, particularly when it comes to stock valuation.

Despite no change to its earnings, Carsales (ASX:CAR) stock has risen 25% over recent months. While its full-year result announced in August was largely positive, Forager's senior analyst Gaston Amoros says the key driver (pun intended) behind this rise has been a change in how investors perceive the business.

For more, watch the video or read the transcript below.

Edited transcript

Alex

Hi everybody. And welcome to this week’s Forager video. My name is Alex Shevelev, senior analyst on the Australian Shares Fund.

Today I’ve got with me guest Gaston Amoros, also senior analyst on the Australian Shares Fund. We’re going to be talking about the car-buying site Carsales. Gas, I’ll hand over to you.

Gaston

Thanks Alex. An interesting one. Basically, the stock has gone up 25%, with no change to earnings. What has happened is what we’d call a change in narrative; a change in perception.

As you know, Carsales makes most of its money selling used cars to dealers. And recently we have seen success in direct to consumer platforms.

You might have heard of the likes of Carvana and Bloom in the US or in the UK, which are a bit of a threat to the existing ecosystem with dealerships. And so that brings us back to Carsales.

So what happened here is at the full-year results in August, the company basically told the market that they are going to be trying to capture a little bit more of the car-buying journey online for themselves much in the same way that REA and Domain have done over the last 10 years or so.

I think the idea is very simple. The process of buying a car today is very time-consuming, as you might know.

You know you've figured out what kind of car you want. You start visiting car lots. The whole process of price discovery is a bit antiquated. There is a lot of room for haggling about with the proverbial used car salesman.

And you know, when you compare that with the simplicity of pre-approved programs, from the likes of BMW and Mercedes, you can see the difference. You know that in a pre-approved program, the cars have been inspected and verified and they’re in good working order.

Very often you're given some kind of guarantee that the car is not a lemon and that if there are any serious faults, you can go back to the dealer.

If those are the conditions, you are pretty much there in terms of your willingness to buy a car online. The only question is whether you have it delivered to you too, or whether you can drive it for like, you know, five days or 2000 kilometres and get your money back if you’re not happy with it.

So that’s the idea and that’s what Carsales is trying to get to. And that’s what’s been revealed in August and that’s the reason why the stock is now up 25%.

Alex

So it’s an interesting idea Gaston, but does it not put the company somewhat at odds with its current dealer client base?

Gaston

Absolutely. That is one of the concerns. I think Carsales has been pretty clear that they don’t want to antagonise their customer base, which are mostly car dealerships.

So they’re doing it in a capital-light manner – ie, they put all the tech and they put the brand, the dealers, they partner with the capital and the participation from the dealer side is optional.

When you think about it, it’s a win-win for both Carsales and the dealer. The dealer gets around the same or slightly higher price for a verified, inspected car with a guarantee.

But very importantly, the dealer also saves some sales commissions, which can be 15%, 20% of the price of a second-hand car. And the price is very visible from the get-go, right?

So the car sells itself. And the long-term, there may be additional benefits from the dealer, like, you know, reducing the amount of showroom space that they utilise or move into cheaper locations further out of town, and also having a lower amount of personnel.

Alex

Since we saw Carsales talk about this, have we actually seen any of it reflected in near-term earnings?

Gaston

Not at all. At this stage it’s experimental, it’s early stage. So we have seen the share price, and that’s why we’re talking about a change in the narrative of the stock. But the numbers, the forecasts, haven’t changed for either FY22 or FY23 on account of this. It’s still pretty early stages.

Alex

So if we then go out maybe three, four, five years or longer – how big could that opportunity actually be for Carsales?

Gaston

It’s potentially very big when you think about the addressable market, which is, you know, the profit pool of the dealers that you could be.

In terms of an order of magnitude of the opportunity, it could add another 50% to the profit pool of Carsales.

Again, it’s still early days – could be a little bit more, a little bit later, but it is quite sizable. And it is sensible, also, that Australia will follow in the path of the US and the UK in terms of migrating some of the car-buying journey online, much in the same way that it has happened with so many other products, you know, from electronics to groceries.

Alex

Right. Thanks for that Gaston – that’s some interesting insights on Carsales. We’ll see everybody next week for the next week’s Forager video.

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