Combined Motor Holdings – an undervalued business with star qualities

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One of the most rewarding aspects of our job is finding a great investment opportunity. Combined Motor Holdings (CMH) is one such gem that remains largely undiscovered, most likely due to its relatively small size. The company has shown exceptional growth in both earnings per share and dividends over the past 20 years. This can be attributed to a combination of two factors – an exceptional management team (who are also shareholders) and an attractive business model with a built-in margin of safety.

CMH has rewarded investors handsomely over the past 20 years

CMH’s primary business is selling new and used motor vehicles through its several distribution outlets around the country. The company represents 19 vehicle brands in South Africa. This diversification provides protection against the temporary fall-offs that some motor manufacturers experience from time to time. The dealerships contribute approximately 65% of the group’s operating profit, with the balance coming from car hire and financial services.

Over the past 20 years, CMH has grown its earnings per share (EPS) by a compounded 13% per year. While there is an element of cyclicality in the business, there has only been one period over the past two decades when earnings took a dip – and that was an extraordinary time for all markets and industries, namely the global financial crisis of 2008/2009. Even more impressive is the growth in dividends (as shown in Figure 1), which surpassed the growth in accounting earnings, compounding at 17% per year for the last 20 years.

Figure 1: CMH’s share price and dividends per share (1997 – 2016)

Source: FactSet

Management’s experience and approach play a key role in CMH’s success

The exceptional performance over the past 20 years is testament to CEO Jebb Macintosh and his incredible management team. Jebb has been on CMH’s board since 1976 and his management style reminds us of that of a typical manager of a Berkshire Hathaway company. At age 70, he is still going strong and has more industry experience than anyone else in the industry. It is this experience, combined with an unrelenting focus on managing costs and cash flow, which has helped the company survive several economic downturns.

We invested in CMH in the SIM Value Fund (which is managed by our Denker Capital investment team) in May 2009 and slowly accumulated over 2.5 million shares between May and November 2009 at prices ranging between R5 and R8. Since then the company has returned R4.40 in dividends. In addition to this, CMH has bought back a further 36 million shares, or roughly a third of the total shares in issue. Overall, the company has returned over R880 million in buybacks and dividends, equating to over 160% of its market cap at the time we started investing.

We love companies that convert a large amount of their accounting profits into cash, especially when the management team are significant shareholders. Collectively the management team of CMH own 42.7% of the shares and strongly support returning cash to shareholders.

We were able to buy CMH at a very attractive price, ensuring a margin of safety

In addition to finding companies with a great management team, there are two more things investors must be mindful of to improve their chances of earning a good return on their investment:

  1. identify companies that generate great returns on capital, and
  2. make sure they don’t overpay for the prospect of promising returns.

Relating to the second point, we invested in CMH shortly after the global financial crisis. That year, CMH achieved financial breakeven and cut its dividend to zero, resulting in its share price plummeting 75% and hitting a low of R4 (as can be seen from Figure 1). It’s normal for us to be buying when there is blood on the streets, and for CMH there was no shortage of bad news at the time. In the 2009 CMH Annual Report, Jebb Macintosh is quoted as saying: ‘this is the most difficult trading period for the retail motor industry in the past 50 years’. National passenger vehicle sales fell 23%; the cumulative fall over the previous 24 months was almost 40%. This was in stark contrast to the predictions made in 2006/2007 that passenger vehicle sales could hit between 800,000 and 1 million vehicles by 2010. Sales for 2008 closed at only 498,900 vehicles.

In our view, there was a significant margin of safety, with the share price trading close to the value of its net current assets on the balance sheet, which was R4.48. Benjamin Graham referred to these as ‘net nets’, and there have been very few instances of these over the past 20 years.

Despite a tough 2009, CMH generated a 29% return on shareholder funds over the preceding nine years (as shown in Figure 2). Even though retail distributorships earn a low margin, they require very little capital from shareholders. This is because vehicles on the showroom floor are funded either by banks (referred to as ‘floor plans’) or original equipment manufacturers (OEMs).

Figure 2: CMH’s growth in tangible book value and return on equity (1997-2016)

Source: FactSet

CMH’s business model and structure also provide a margin of safety

In addition to the very attractive share price, the CMH business model has several other appealing traits, similar to those that Warren Buffett recognised when purchasing the fifth largest car dealership in the US. (In 2014, Berkshire Hathaway bought all the shares of the Van Tuyl Group, which has been privately owned since 1955.) For CMH, the following factors provide a reasonable margin of safety during a downturn:

  1. The company is significantly diversified across several brands, reducing its heavy reliance on any one OEM.
  2. A large proportion of the fixed costs of owning a dealership is covered by the more stable revenues earned from the maintenance and parts division.
  3. When new vehicle sales decline, the sale of second hand vehicles normally picks up. Since the gross margins on second hand sales are much higher than the margin on new vehicles, this countercyclical behaviour supports profitability. In addition, there is a large guaranteed supply of second hand vehicles from CMH’s car rental business (First Car Rental), which was established in 2008.

Going forward, we believe CMH holds the potential for continuous growth

New passenger vehicle sales have declined for three years in a row. Despite the challenging environment, CMH has managed to continue to grow profits and dividends. With the potential for some consumer relief from interest rate cuts later in the year, we think we are at the bottom of the cycle for new vehicle sales. In fact, we still see the potential for above-average returns for CMH shareholders.





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