EUR 850.00 For Business Accounts Only

Morningstar | CAR Updated Star Rating from 23 Aug 2018

Narrow-moat-rated Carsales.com reported a good fiscal 2018 financial result but one which was broadly in line with our expectations. Although the 19% increase in revenue was higher than our 17% forecast, EBITDA growth of 16% was lower than the 20% we expected. The result was also distorted somewhat by the change in accounting policy for SK Encar following the increase in Carsales.com's ownership to 100% from 49% in January 2018. Although the result was good, we don't believe it warranted the 10% share price jump which followed the announcement.

We have increased our fair value by 4% to AUD 14.50 which largely reflects the time value of money impact on our financial model. However, at the current market price of AUD 16.25, shares are overvalued. The market price implies a fiscal 2019 price/earnings ratio of 28, versus 25 at our fair value, and a dividend yield of 3.1%, or 4.4% including franking credits. Management didn't provide much fiscal 2019 guidance, as is usually the case, but expects the domestic core business to grow at a similar rate to fiscal 2018 and that profit growth will be "solid." This compares with our forecast of 9.6% EBITDA growth for the domestic business, versus 9.4% in fiscal 2018.

The fiscal 2018 result provided Carsales.com investors with increased confidence for a number of reasons. First, the company continues to generate strong growth from its dominant domestic business, which comprises around 75% of group EBITDA and which increased revenue by 10% and EBITDA by 9% in fiscal 2018. Like the other main online classified advertising platforms, revenue growth is being driven by price rises rather than volume growth and we expect Carsales.com to continue to leverage its network effect based economic moat and associated pricing power for the foreseeable future.

Second, Carsales, is successfully diversifying into adjacencies to its core business with its data, research, and services division, which comprises around 10% of group EBITDA, continuing to grow nicely, with revenue up 7% in fiscal 2018 and EBITDA margins of 59%. We expect this business to continue to grow at similar rates for the foreseeable future, with growth supported by expansion into the international businesses where data can be leveraged easily due to the internationally homogenous nature of cars.

Third, Carsales.com's international expansion plans are progressing well and the company reported good growth in South America, in contrast to Seek's challenges in the region. Although Carsales.com's South American businesses are relatively small, comprising only 2% of group revenue, the company has leading positions in a number of countries and the addressable markets and growth potential are huge. Key performance indicators are improving, and we forecast a revenue CAGR of 26% for the division over the next decade. We also expect the South Korean business, which comprises 14% of group EBITDA, and is now fully owned, to continue to grow and we forecast an EBITDA CAGR of 9% over the next decade.

We remain cautious about the finance division, which comprises just 5% of group EBITDA, which we believe lacks the competitive advantages enjoyed by other areas of the company, but we accept that this business strengthens customer switching costs. However, since its acquisition in 2014, the division has experienced a number of issues and the Royal Commission into the financial services sector creates further uncertainty. EBITDA fell by 4% in fiscal 2018 but we expect the business to overcome short-term issues and stabilise before returning to mid-single-digit annual revenue growth. Encouragingly, leads generated by Carsales.com continue to be strong and issues appear to be more related to lead conversion which is a problem we expect to be solved.

Like its online classified peers, Carsales.com operates a capital-light business model that generates good cash flows and which enables relatively low financial leverage and sustainable dividends. In fiscal 2018, cash conversion was impacted slightly due to the working capital impact from the consolidation of SK Encar. However, we expect cash flow to recover in fiscal 2019. We're not concerned by the 154% increase in net debt in fiscal 2018 to AUD 390 million which reflects the acquisition of SK Encar. Debt metrics remained comfortable as at June 30, 2018, with net debt/EBITDA of 1.9 and the EBIT/interest cover of 18, and we expect these metrics to steadily improve over the coming years.