Today's profit warning from car supermarket firm Motorpoint Group (LSE: MOTR) highlights the risks of investing in new flotations. All too often, the seller wants to cash in before trading conditions become more difficult.
In this article I'll explain what's gone wrong at Motorpoint and highlight why I believe car dealership group Vertu Motors (LSE: VTU) is likely to be a far more profitable (and safer) investment.
Referendum hits sale
Motorpoint shares fell by 20% this morning, after the company said that uncertainty following the EU referendum had forced management to cut prices. Used car dealers tend to rely on financing to fund their stock purchases, so they can run into problems quite quickly if stock levels get too high. Slashing prices is generally the only way to speed up sales.
Today's statement says that both sales volumes and profit margins were below expectations during the first half. However, group revenue rose by 11% and like-for-like sales were positive.
My reading of this is that the three new sites opened over the last 12 months are probably providing most of the revenue growth, with modest like-for-like growth at some existing locations. As Motorpoint has chosen not to provide more detailed figures, I think it's prudent to take a fairly cautious view of the group's revenue growth.
Current broker forecasts indicate that Motorpoint was expected to report full-year earnings of 16.8p per share this year. The company says that trading has improved during the second half, but I'd still expect these forecasts to be downgraded slightly after today's news.
Buy or sell?
I'm guessing that around 10% will be shaved off broker forecasts after the news. This would leave Motorpoint shares trading on around 8.5 times forecast earnings, with a prospective yield of 3.2%.
These figures may look attractive, but it's worth noting that Motorpoint only floated in May and has already issued a profit warning. We don't yet know how credible management guidance really is.
A second weakness of this business is that it's dependent on low margin car sales. Unlike franchised car dealers, used car supermarkets can't use sales to build up a pipeline of more profitable after-sales work.
As you can probably guess, I won't be investing any of my cash in Motorpoint shares.
A better buy?
I'm much more attracted to car dealer group Vertu Motors. This well-established firm is the fifth largest motor retailer in the UK, with more than 130 dealership locations. Vertu's share price was hit hard by the referendum vote and is down by 46% so far this year.
However, the group's trading has remained strong. Revenue rose by 17.7% to £1,454m during the first half, while pre-tax profit rose by 14% to a record high of £18.7m. Vertu has no debt and reported strong trading during the plate change month of September.
Management expects full-year results to be in line with expectations. This gives the stock a forecast P/E of 6.7 and a prospective yield of 3.3%. In my view, this could be a good opportunity to invest in a company that's out of favour but has strong fundamentals.
Don't buy anything before reading this
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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Vertu Motors. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.