CARG - Cars.com Improves Guidance As Car Market Shifts (Rating Upgrade)

2023-10-20 18:11:05 ET

Summary

• Cars.com Inc. connects buyers and sellers of cars in the U.S. and offers value-added services.
• The U.S. market for used automobiles is expected to reach $302 billion by 2027.
• Cars.com's recent financial trends show slow revenue growth but a sharp rise in earnings per share.
• Given the stock’s potentially favorable valuation, a market shift toward the need for dealers to move inventory, and management guidance for 2023 revenue growth, my outlook is a Buy.

A Quick Take On Cars.com

Cars.com Inc. ( CARS ) has developed an online system that connects buyers and sellers of used cars in the U.S. and provides other related value-added services.

I previously wrote about CARS with a Neutral Hold outlook.

Given the stock’s potentially favorable valuation, a market shift toward the need for dealers to move inventory and management’s guidance for 2023 revenue growth, my new outlook on CARS is a Buy at around $16.25 per share.

Cars.com Overview And Market

Illinois-based Cars.com was founded in 1998 to provide an online service that enables used car buyers and sellers in the United States to transact their vehicle purchases.

The company is led by president and CEO Alex Vetter, who has been with Cars.com since 1998 and was previously in business development at Classified Ventures and the Tribune Company.

The firm’s main service offerings seek to integrate its consumer-facing website with automobile dealerships to enable customers to access advanced shopping features and value-added services, including financial services.

According to a 2022 market research report by Mordor Intelligence, the U.S. market for used automobiles was estimated at $196 billion in 2021 and is expected to reach $302 billion by 2027.

This represents a forecast CAGR of 7.51% from 2022 to 2027.

A primary reason for this expected growth is a return to normalcy after supply chain shocks as a result of the pandemic and related factors.

However, a higher interest rate environment has reduced automobile affordability for some consumers, leading to variability in demand and price in recent quarters.

Major competitive or other industry participants include:

• CarGurus ( CARG )

• CarMax ( KMX )

• TrueCar ( TRUE )

• CarBravo

• AutoNation

• AutoTrader.com

• KBB.com

• Edmunds.com

• CarsDirect.com

• CarFinder.com.

Cars.com’s Recent Financial Trends

Total revenue by quarter has risen slowly recently; Operating income by quarter has dipped in recent quarters:

Gross profit margin by quarter has trended slightly lower recently; Selling and G&A expenses as a percentage of total revenue by quarter have moved higher in recent quarters:

Earnings per share (Diluted) have risen sharply in the most recent quarter:

(All data in the above charts is GAAP.)

In the past 12 months, CARS’ stock price has risen 30.1% vs. that of the CarGurus ((CARG)) rise of 30.97%:

For balance sheet results, the firm ended the quarter with $28.6 million in cash and equivalents and $451.0 million in total debt, of which $16.8 million was categorized as the current portion due within 12 months.

Over the trailing twelve months, free cash flow was $123.1 million, during which capital expenditures were $19.3 million. The company paid $24.2 million in stock-based compensation in the last four quarters, the highest trailing twelve-month figure in the past eleven quarters.

Valuation And Other Metrics For Cars.com

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

Below is an estimated DCF (Discounted Cash Flow) analysis of the firm’s projected growth and earnings:

Based on the discounted cash flow ("DCF"), the firm’s shares would be valued at approximately $20.15 versus the current price of $16.21, indicating they are potentially currently overvalued.

As a reference, a relevant partial public comparable would be CarGurus; below are the comparable metrics:

(Source - Seeking Alpha.)

Sentiment Analysis

The chart below shows the frequency of various keywords in management’s most recent conference call:

The chart suggests that the firm is facing continued macro headwinds as well as average revenue per dealer suffering from a loss of digital dealers this year.

Analysts asked company leadership about the reasons for its increased 2023 revenue guidance, dealer churn and dealer spending trends.

Management said that the company's marketplace repackaging is driving average revenue per dealer higher among the dealers that are moving to the upper-tier packages.

It appears that dealer churn appeared to have stabilized in July (after the end of Q2) versus June declines, and their focus has now shifted to cross-selling and related initiatives.

Management noted that dealers are showing increasing interest in media spending to move inventory as the market shifts back to a more normalized state after severe inventory shortages.

Commentary On Cars.com

In its last earnings call (Source - Seeking Alpha ), covering Q2 2023’s results, management’s prepared remarks highlighted the faster growth in dealer revenues of 6% versus total revenue growth of 3%, year-over-year.

The company is more than 60% complete with its ‘marketplace repackaging initiative’ and is seeing improved demand from two-thirds of its dealer base opting for the upper-tier packages.

Management expects additional benefits from this initiative to materialize in Q3 as it finishes its repackaging work.

The June retention rate was at a historical high, although management didn’t provide any specifics.

Gross profit margin fell 0.6% YoY, and Selling and G&A expenses as a percentage of revenue rose 0.9%, indicating less efficiency in this regard.

As a result, operating income dropped 20.1% year-over-year to $12.3 million for the quarter.

The company's financial position is moderate, with some liquidity, material long-term debt but strong free cash flow.

Looking ahead, 2023 top line revenue growth is expected to be around 4.8%, which, if achieved, would be about the same as 2022’s growth rate over 2021.

In the past twelve months, the firm's EV/EBITDA valuation multiple has risen by 6.3% net-net, as the chart from Seeking Alpha shows below:

A potential upside catalyst to the stock could include continuing benefits from management’s repackaging initiative and the potential for increased demand from dealers returning to the system as they need to move inventory.

Given the stock’s potentially favorable valuation, market shift and management’s guidance for 2023 revenue growth, my outlook on CARS is a Buy at around $16.25 per share.

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