Small Caps | Nov 02 2015
-Sells main fixed price retail exposure
-Volatility highlighted in earnings
-Several sources of growth
By Eva Brocklehurst
Online auction platform Grays eCommerce ((GEG)) is re-positioning its offering in the industrial business-to-business (B2B) and business-to-consumer (B2C) market. Moelis initiates coverage on the stock, highlighting the company's established brand name and scalable infrastructure that enables efficient and profitable growth.
Grays has announced the sale of its fixed price retail (FPR) business to MySale this month for $5.2m, a positive development in the broker's view. The transaction includes dealsdirect.com.au, OO.com.au and topbuy.com.au.
Work is still to be done to rationalise the existing high fixed cost base of this business and a full exit is likely to take some time. The company will continue to operate the FPR business over Christmas and Moelis expects earnings from this segment will be separately reported as discontinued.
Grays will continue to operate auction-based B2B and B2C but exit the majority of its fixed price retail consumer exposure, selling just a small amount on graysonline.com and grayswine.com.au. Moelis calculates that Grays wine sales contributed $30m in revenue with a 10% earnings margin. While profitable as a stand-alone business, Moelis suspects a spin off is possible for the right price.
Moelis is cautious about a lack of historical trading records and the potential for earnings to be "lumpy", but notes the company's strong cash-flow conversion and net cash position.
Typically, in the case of used equipment, sales are counter cyclical, driven by period of lower demand across industries that lead to idle capacity and excess inventory. This volatility can be mitigated, Moelis expects, via operating in a broader range of markets. The net effect is the broker anticipates some volatility in earnings over the longer term.
There are several sources of growth on offer, particularly in the business to business segment and margin leverage from a relatively fixed employee and warehousing cost base. Bolt-on acquisitions are also a potential source of additional scale, Moelis maintains. In July Grays acquired DMS Davlan, a company auctioning agricultural machinery in Australia and which currently operates a physical marketplace.
Moelis has a Buy rating and target of $1.40. The broker calculates valuation on a diluted basis that includes potential bonus shares to be issued next month, with upside considered eminently achievable.
Grays was established in 1989 and listed in November 2014 via the amalgamation with Mnemon. The company has the largest online auction-based B2B business in Australia and has the third largest online wine sales website in Australia.
B2B involves industrial and commercial equipment, with significantly higher margins and a fairly fragmented market, Moelis contends, while B2C is typically more competitive and driven by high volume and a low margin business model.
Earnings contributions vary, with B2C contributing 71% of Gray's FY15 revenue but negative earnings in the most recent numbers. Moelis expects a modest FY16 contribution from B2C to earnings, driven by the wine business. B2B earnings margins improved to 23% in FY15 from 17.5% and are expected to remain in this vicinity in the medium term.
Typically, Grays operates on consignment, taking minimal inventory and working capital risk but receiving lower average margins. There is therefore no obsolescence or sale risk attached to the inventory.
The majority of the company's supply is from insolvency practitioners, state and local governments and financiers as a result of situations like site and plant closures, relocations and excess inventory. Companies such as Coates Hire and Fitness First provided excess or used equipment for sale as well.
The broker notes online auctions have grown by 8.0% compound between 2010 and 2014 and represent 20% of the auction market. The company's platform supports international expansion, with Moelis singling out South East Asia as a particular area of potential. Auctions in that region are significantly lower than in Australia.
The company operates a single warehouse and distribution centre in Homebush, NSW. Customer support in Manila, Philippines, is likely to be reduced post the MySale transaction.
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