Shares of nearly-new used car specialist Motorpoint Group (LSE: MOTR) motored 6% higher to 155p when markets opened today, after the firm said sales had accelerated 12.7% to £822m last year.
But these early gains soon stalled, perhaps because pre-tax profit fell by 30.7% to £11.7m last year. This pushed adjusted earnings down by 13.6% to 12.7p per share. One bright spot for shareholders was that a final dividend of 2.9p per share means the full-year payout has risen to 4.23p per share, giving a yield of 2.8%.
Why have profits fallen?
These figures seem to suggest that profit margins collapsed last year. That’s not entirely true. Despite a slow period following the EU referendum last year, Motorpoint’s gross profit margin on each car sold was almost unchanged, at about 7.6%.
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Profits fell because of costs relating to site openings, and rising administrative costs. The value of the firm’s inventory of used cars rose by £23.5m to £98.4m last year, as it increased stock levels to support a higher number of sites.
That seems reasonable enough, but I’m concerned about the increase in overheads. Administrative costs rose by 50% last year, from £24m to £32m. Does an increase from 10 to 12 sites really require such a hefty increase in overheads? I’m not convinced.
While trading appears to remain strong, my view is that Motorpoint may not be very well positioned to deal with a slowdown. The group has increased stock levels, opened new branches and scaled up its central overheads. A slowdown could cause profits to collapse. It currently trades on 12 times trailing earnings with a yield of 2.8%. I wouldn’t chase this one any higher.
Is the market turning on this stock?
FTSE 100 newcomer ConvaTec Group (LSE: CTEC) makes medical supplies such as colostomy bags. Sales rose by 2.3% to $1,688m last year, which is the kind of pedestrian growth I’d expect from a business like this.
However, recent acquisitions and restructuring appear to be driving a big improvement in profit margins. ConvaTec’s adjusted operating margin rose from 26.5% to 28% last year. Adjusted earnings per share rose by 30% to $0.13 in 2016, and are expected to rise by a whopping 46% to $0.19 per share in 2017.
Given all of this, you may think that the shares deserve their lofty forecast P/E rating of 22. That may be so, but I’m concerned that investors face several risks that could limit further gains.
My first concern is that net debt is high, at $1,722.9m. ConvaTec’s ratio of net debt to adjusted EBITDA was three times at the end of 2017, well above my preferred limit of two times. Interest costs are also high — the group spent $270.6m on cash interest payments in 2016. That’s equivalent to more than half its adjusted operating profit of $472m.
It’s also worth noting that this rapid earnings growth isn’t expected to continue. Analysts have pencilled-in forecast earnings per share growth of 9.9% for 2018, leaving the stock on a 2018 P/E of 20.
The shares have already fallen by nearly 10% from their peak of 349p. In my view, further falls are likely as the stock’s valuation adjusts to reflect ConvaTec’s high debt levels and likely slower future growth.
