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2013-10-12 I've updated my valuation of CMH to take into account the interims to August 2013. I see CMH as being worth some R17 a share:

• I require a return of 7.5 % (i.e. the 5-year rate on retail saving bonds), plus a spread of 6% (a bit less than my average requirement, as I'm comfortable that CMH's past earnings have been fairly consistent, albeit cyclical, with stable management).

• I assumed future growth in owner earnings of 5.75% p.a.

• I assumed that shares in issue continue to be diluted at a rate of 0.2% p.a. for the next 20 years.

I adjusted owner earning upwards to take into account:

• I didn't take into account that September 2013 new car sales were 0.8% higher than September 2012 (used car registrations for September 2013 aren't out yet).

• Passenger arrivals at O.R. Tambo, which I use as a rough proxy for the number of car rentals required, didn't have figures for September 2013 out yet.

Factors not taken into account:

• Rand weakness may feed into certain types of inflation (including the cost of imported vehicles), resulting in a deterioration in purchasing power, as well as increasing the probability of an interest rate increase.

• The Reserve Bank have dropped repo rates to a 30 year low of 5%.

• The frequency with which people trade vehicles may increase in the future, as a result of increases in fuel prices leading to a shift to more fuel efficient vehicles (and eventually electric vehicles), and the introduction of driverless cars.

I'll leave it for readers to decide what weight to place on the factors going forward.

Key People

Jebb McIntosh, CEO (on board since 1976)

JTM Edwards, Chairman (since 2013)

Stuart Jackson, Financial Director (on board since 1986)

Mark Conway, Executive Director (on board since 2000)

About Combined Motor holdings

CMH operates mostly in the retail motor & related sectors in South Africa, including offering full maintenance leasing & insurance on vehicles sold:

Retail motor

In 2011 CMH integrated MG & Maxus brands into existing dealers to save on overhead expenses. Both MG & Maxus brands are owned by the Shanghai Automotive Industry Corporation. Maxus is a commercial vehicle brand with its roots in LDV, a British van manufacturer. CMH are introducing a Maxus minibus & pick-up in SA. MG is the abbreviation of Morris Garages.

A risk facing the dealerships is that the car-makers go bankrupt, as General Motors & Chrysler nearly did in 2009.

Web-based marketing concentrates on the CarShop brand, and in their 2010 financial report they mentioned that more than two thirds of CMH's used car leads are generated off the internet. In their 2011 report CMH said that sales leads from Carshop continues to increase.

On the expense side, the 3 overhead expenses with the highest value in a typical dealership are staff costs, property rentals & demonstration vehicles/petrol.

What factors impact new car sales?

• Disposable income, which is impacted by many factors - fuel, food & electricity prices, level of indebtedness & interest payments thereon.

• The average buyer requires finance, so any change in lending conditions & rates

• New ranges (e.g. CMH have launched the importation & retail distribution of the MG in the second half of their 2012 financial year, being marketed by 7 Group & 5 independent dealerships)

• The price of vehicles, which is impacted by many factors, e.g. the depreciation in the Rand could impact vehicle prices, an increase in interest rates increases the repayment schedule, carbon emissions tax

Should sales reduce then inventory could be decreased & unprofitable operations closed (although in some instances the lease rentals may have to be carried although the premises are vacant).

The parts & workshops/services provide a steady & dependable base of income, from cars in the 1 to 5-year old range. It's unfortunately not clear what portion this makes up of the retail motor profit, although in their 2012 report CMH says that they enjoyed revenue increases of 13% (parts) & 16% (services).

First Car Rental

The brand "First Car Rental" was launched in April 2008, and is becoming a trusted and established brand name in South Africa. It has an alliance with Sixt Car Rental, a European brand based in Germany. Bruce Barritt is Managing Director.

Their profit in part depends on the prices achieved on the sale of replaced fleet vehicles. Vehicles are mainly sourced directly from the manufacturers, and in many cases vehicles are purchased on a buy-back arrangement and, at the end of the period may be sold back to the manufacturer at a pre-agreed price. The remainder of the 1-year old vehicles are sold back into the Combined Motor Holdings Group at market-related prices. Accident-damaged vehicles may be sold through Bonerts.

A weak ZAR exchange rate encourages foreign tourists to South Africa and therefore car hire business from them.

Should demand change, then the fleet size is adjusted.

It's concerning that First Car Rental have a poor ratio of compliments to complaints on HelloPeter.

Marine & Leisure

Consists of CMH Marine & Leisure, Waterworld is located in Cape Town and Randburg. The division holds the franchise rights for quality brands (Sea Ray, Supra, Evinrude & Can-am), and the hope is that it will lead the way during better economic times.

From 26 July 2012 CMH Marine & Leisure are selling Husqvarna motorcycles (the Swedish company, now a BMW Group company, has been building them since 1903, making it the 3rd oldest motorbike manufacturer after Triumph & Harley-Davidson). The Husqvarna Nuda 900R has a reputation as a hooligan bike. In a Moneyweb article Fred Fensham, General Manager of CMH Marine and Leisure,  said that the "initial investment by CMH Marine & Leisure into the brand roll-out will be about R6m. This does not include investments that will be made by the dealership owners themselves into the physical infrastructure". "Fensham said that the full range will be available at the start for CMH to “read the market” and then after about 18 months they will refine the model offering depending on demand."

Financial services

Warranty, credit life, vehicle insurance, CMH Finance & CMH Insurance.

Losses may occur following cancellations and defaults on insurance policies and bad debt writeoffs, but according to the 2010 annual report, the Group is protected against, and does not bear collective losses from JVs with finance houses, but only starts sharing in positive results when the deficits have been recovered. Happily, the situation at 31 August 2011 was that "trading deficits recorded in the Group's joint ventures with finance banks in prior years have all but been wiped out and a modest positive contribution was earned during the period."

As "fresh" business is added following an increase in new and used vehicles, the financial services has the potential to generate annuity-type income.

In their 2012 report CMH said that "policy premiums have been outsourced to a collections agency & the result has been an improved collections rate & a reduction in early lapsing of policies."

Trading CMH takes patience

When it comes to trading you've probably done a load of work, and may be chomping at the bit to do your trade. Be careful here, as impatience can cost you a lot of cake. Directors control some 70% of the issued shares of CMH, the advantages of which I think outweigh the disadvantages, but do contribute to it being a thinly traded counter - it may only trade twice a day, and a lack of patience at the point of trade may mean that you're the one crossing the bid-offer spread, it's not unusual for this to be over 5% of the value. To give you an idea of what is required, when I bought my CMH shares, it was only after 2 trading days of having the highest bid, that somebody bought my shares (of course being patient also means running the risk of the price moving and the deal running away from you).

Disclosure

This article's author has various interests in the CMH Group, including owning shares in CMH, and being an active trader in the stock.

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