Shares of Cars.com (NYSE:CARS) continue to look strong at 15% YTD. Despite the difficult macroeconomic situation, the company continues to demonstrate both revenue growth and a stable level of operating profitability. Thus, I believe that the company retains fundamental potential for growth in the next periods based on my DCF model.
For a more accurate understanding of future cash flows, I made my own forecasts based on historical data and my personal expectations.
Revenue growth: in my forecast, I use conservative assumptions that the company will continue to show stable revenue growth at the level of 5%, which is slightly above the inflation rate.
Gross profit margin: in my model, I set the gross margin at a stable level of 82% based on historical data. I believe that the company will not be able to aggressively increase its own remuneration in view of the high competition in the sector.
Product and technology: in my model, I include a gradual reduction in costs (% of revenue) from 13.5% in 2022 to 13.3% in 2026 due to the growth of economies of scale and efficiency levels.
Marketing and sales: I’m budgeting at a steady 33.7% (% of revenue) because I don’t think the company will be able to show much improvement in this line of spending as marketing cuts could put pressure on revenue .
General and administrative: with increasing economies of scale and better governance, I expect spending (% of revenue) to drop from 10.6% in 2022 to 10.2% in 2026.
To value Cars.com, I prefer to make assumptions about future cash flows and build a DCF model because:
1) The company operates in a clear and stable market where investors can make assumptions about the company’s market growth rate and market share 2) The company has a history of reporting and observations based on which I can model future operational and financial performance
To build a DCF model, I use the following inputs:
Terminal growth rate: 3%
Macro: rising consumer spending on the back of a recovery in consumer confidence and lower interest rates could have a positive impact on consumer spending in the automotive segment, which would have a positive effect on business revenue.
Market share: effective marketing spending and new M&A can support the company’s revenue in future periods.
Margin: an effective management approach to managing operating costs can support the operating profitability of a business.
Macro: decreasing consumer confidence and falling real consumer incomes could lead to lower spending on new and used vehicles, which could have a negative impact on the company’s revenue in future periods.
Competition: increasing competition, increased marketing activity and dumping can have a negative impact on revenue growth, market share and profitability.
Despite the still difficult macroeconomic conditions, the company continues to demonstrate revenue growth and maintain operating margins. I believe that the recovery of consumer confidence, the company’s stable market position and effective M&A will support the growth of the company’s business, and the increase in economies of scale will help maintain effective management of operating expenses. In my personal opinion, the fair share price is $24 with an upside potential of 52%.