Australia | Mar 26 2014
-Strong long-term earnings potential
-Strategically sound deals
-Higher margins, improved logistics likely
By Eva Brocklehurst
Automotive Holdings ((AHE)) has made two substantial acquisitions with a strong rationale to increase scale and diversity. Hence, the deals have been welcomed by brokers. The company will acquire Sydney-based Scott's Refrigerated Freightways for $116m and Bradstreet Motor Group for $68m, funded by debt and an equity placement of $115m. Management has also confirmed approaches by prospective buyers for the Cov retail stores in Western Australia but discussions are preliminary. Morgan Stanley observes such a sale would be well received by the market as it would divest a non-core business.
Both the new businesses have higher operating margins than existing AHE operations, with Scott's providing increased flexibility in road transport. Scott's will take over the remainder of JAT Refrigerated Road Services it doesn't own to incorporate that into the acquisition. Scott's will provide a truly national cold storage business and AHE will become the largest cold transport and storage provider in Australia. Bradstreet will provide 13 automotive dealerships in NSW, countering the overweight representation of Western Australia. After the acquisitions AHE will have net debt of 17.1% of assets and around $70m in undrawn facilities.
Morgan Stanley thinks Scott's will add network scale and long-term earnings growth. AHE has identified $4m in synergies from cold storage, supplier terms and other savings. This provides a strong cornerstone in cold chain logistics with scope to grow, the broker contends. Morgan Stanley expects the combined logistics division to reach $1bn in revenue in FY15. This would warrant a significant premium to AHE's trading multiple if the company can execute the strategy well. The Bradstreet dealership increases the company's share of favoured brands and also provides a new market in Newcastle. Morgan Stanley believes AHE is a compelling investment and has upgraded to Overweight with a target of $4.50, expecting earnings growth of above 20% from FY15. The company's market share is expected to rise to over 10% of the automotive retail market in the medium term, from around 5% currently.
BA-Merrill Lynch likes the Bradstreet deal, as AHE continues to consolidate a fragmented market and drive scale benefits. There is significant further opportunity for margin expansion and the broker believes the industry is less cyclical than the market fears. This is a straight forward acquisition. Merrills is less impressed with the Scott's acquisition, given disappointments in the past with the Harris acquisition, but acknowledges the scale benefits of a larger network. Management alluded to trading continuing in line with expectations. This reassures Merrills, given the soft car sales numbers from some quarters. The broker expects the combined acquisitions will be 12% earnings accretive from FY15.
The deals make strategic sense to CIMB. The broker is conscious that the Scott's deal increases the company's exposure to the underperforming cold storage and transport business. Nevertheless, there is potential for increased efficiencies. CIMB's analysis suggests the Bradstreet acquisition adds the same accretion to earnings per share as does Scott's, despite being almost half the price. Scott's higher skew to road transport compared with AHE's existing business means there's less subcontracting and the diversity of customers and freight types reduces seasonality and exposure to climatic events. All these are positives in CIMB's view. The broker has run a bull case scenario to incorporate the targeted synergies into FY15 forecasts. This implies FY15 earnings accretion of 11.5% and on that basis AHE would be trading at 10.1 times FY15 price/earnings. CIMB has not incorporated the acquisitions into forecasts but, if so, this would increase the valuation to $5.11. The broker retains a $4.66 target.
UBS notes both acquisitions are yet to be finalised but, also taking the opportunity to reflect the impact on estimates, expects FY15-16 earnings will be lifted by 10.7-14.8%. UBS expects higher margins will be derived from the increased scale in transport and cold storage and this should improve returns for AHE's logistics division. The expansion in automotive dealerships reflects the company's long-term strategy of diversification in order to provide a more stable earnings platform. In FY13 Bradstreet generated $449m in revenue with an earnings margin of 3.5%.
It's all positive from a strategic and financial aspect, according to Deutsche Bank. The multiples paid are also reasonable and the broker thinks the Scott's acquisition could be the catalyst for improving the company's underperforming logistics business. The broker lauds AHE's record in obtaining value upside from automotive acquisitions as the industry is well suited for consolidation.
As for the logistics business, the experience has been less than impressive, Deutsche Bank concedes, but not altogether poor. Since the acquisition of Harris in 2011 and the loss-making Toll Holdings ((TOL)) assets in 2012, cold logistics have increased earnings by 50% but incremental earnings generated returns on invested capital of just 10%. Far from attractive, Deutsche Bank observes. In AHE's defence, the company has pursued a strategy of expanding and upgrading facilities across the country and this is only partially complete. Deutsche Bank believes the benefits from Harris and Toll and potential benefits from Scott's will take time to realise but will be enhanced by the network breadth offered by Scott's.
On FNArena's database the stock has five Buy ratings and two Hold. The consensus target is $4.36, suggesting 15.7% upside to the last share price. On FY14 forecasts the dividend yield is 5.7%. On FY15 it's 6.3%.
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