Here’s the next FTSE 100 stock I’m going to buy

Auto Trader (LSE: AUTO) is a FTSE 100 stock I’ve had on my watchlist for a few months now. It’s down 28% over the last year, though it’s only fallen 6% in the last six months. I don’t think that’s too bad considering all the gloomy forecasts for the UK economy in recent months.

Here’s why I’m finally buying some shares.

Market leader

Auto Trader operates the UK’s largest online marketplace for buying and selling vehicles. It’s predominantly a classified advertising business, though it does upsell value-added services to its customers.

The site features more than 450,000 cars on any given day, giving buyers access to over 80% of the UK’s automotive retailers. Two out of every three of its partners’ used car sales were generated from its platform in 2021.

The company benefits from the network effects produced by its scale.

Data-driven

Auto Trader has grown its tech team considerably in recent years. These developers are employees (not contractors), which management believes gives them a vested interest in the long-term performance of the company’s products. They ‘own’ the code base, as it were, rather than looking for quick fixes.

Catherine Faiers, Auto Trader’s COO, has said: “We’ve got a brilliant software stack, which allows us to be incredibly agile. I see that as our biggest strength – more so perhaps than even the brand, our history and other assets.”

The group monitors over 1.9m vehicles every day. It can give real-time feedback to retailers concerning the speed at which individual cars are selling and at what price. This can lead to more sales and increase profitability for its partners.

Auto Trader’s large amounts of data give it a clear competitive advantage.

Strong trading

Full-year 2022 revenue (year ending March 2022) was £432m, which was up 65% from the year before. However, the previous trading year was massively disrupted by Covid. So it’s probably more appropriate to asses growth over a two-year period.

If we do that then revenue was up 17% on 2020 (£368m). Operating profit was £303m, also representing a 17% increase from 2020. I’m encouraged that profitable growth has continued beyond pre-pandemic levels.

The stock now has a price-to-earnings (P/E) ratio of 20. That’s a cheaper valuation than previous years. Plus, there’s also a modest dividend with a yield of 1.6%.

Pricing power and risks

Being able to raise prices over time without losing customers is one of the hallmarks of a strong business. Evidence of Auto Trader’s pricing power is shown by the steady growth in its average revenue per retailer (ARPR) per month.

That’s the average monthly amount each professional car dealer pays the platform. And it has gone from £996 in 2012 to £2,210 in 2022.

However, car dealers operate in an extremely competitive market, often with modest profit margins. So the company cannot go on squeezing more from its existing customers forever. It’ll have to utilise its data more creatively to provide additional value for its customers.

On top of this, the demand for used cars may soften considerably during a recession. Over the long term though, I expect car buying to continue moving online. As the established and trusted digital platform, Auto Trader should continue to benefit from this transition.