Burson Offers Upside In Automotive Sector

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-Potential for margin expansion
-WA  a geographical catalyst
-Private label penetration important
 

By Eva Brocklehurst

Burson Group ((BAP)), Australia's largest distributor of aftermarket parts to the automotive trade, is now a listed entity and brokers responded warmly to the company's IPO, the main difference in viewpoints being just how much upside is expected in the near term.

The company sells 85% of its products to trade customers and Do-It-Yourself vehicle owners. The industry is relatively defensive, and trade customers value speed of delivery and knowledge about parts above pricing. The company's name is highly regarded. Structural changes occurring in the industry – vehicles are becoming increasingly complex – have led to a requirement for parts to be held in the supply chain. Burson is well placed to capitalise on these opportunities. Margin expansion also exists, through increasing direct sourcing and private label penetration.

Morgans thinks the scale and distribution of Burson's network provides the key advantage via an integrated supply chain. The broker expects the company to continue with its record of consolidating the industry and rolling out greenfield stores. Western Australia, where Burson has no presence yet, is expected to be the next target and presents a near-term catalyst. Funding is expected to come from operating cash flow and available debt facilities. The stock is trading on FY15 price/earnings of 14.5x and broadly in line with its peer group, in Morgans' calculations. The broker is attracted to the defensive nature of this industry and the company's acquisition potential. Morgans initiates coverage with a Hold rating, given the stock is already trading at a fair valuation. The broker's target is $2.00.

The company is targeting an increase in its private label penetration to 25% over four years, from 10% currently, which UBS believes will have materially positive impact on gross profit and earnings. The broker considers the company's targets are realistic, given Burson is not represented in some regions and vehicle workshop chains are growing their market share and increasingly demand national warranties. UBS values Burson using blended methodologies and initiates coverage with a Buy rating and price target of $2.30. The broker observes some risk that Burson becomes a takeover target in the future, maybe from Super Retail ((SUL)) or another domestic or large international competitor.

Morgan Stanley finds the company's model deceptively simple, yet robust, and initiates coverage with an Overweight rating and $2.25 target. The broker is looking for Burson to augment underlying 3% annual revenue growth with an expanding store network. Morgan Stanley does not see a changing industry structure, or ownership ratios, having a significant earnings impact on Burson in the near term, with the company's service and relationships a greater consideration for customers. The broker agrees the obvious step would be an acquisition in Western Australia and expects Burson to grow underlying earnings by at least 10% over the next few years.

The company's gross margin has widened to 42% from 39% in the past three years, initially through a re-setting of the price base and subsequently through better supplier terms. Morgan Stanley expects gross margins to continue to widen as a function of continuing revenue growth, improved supplier terms and through internal initiatives, such as increased direct sourcing and private label products. The broker also thinks the experience of the US automotive aftermarket parts industry is revealing. In the past ten years the ten largest competitors have increased their combined market share to in excess of 50%, from 31%. Also, in the case of market leaders such as O'Reilly, they have been able to lift gross margins above 50%. The relative size of the US market versus Australia raises the question of whether Burson can achieve equivalent margin growth but otherwise Morgan Stanley finds the company's outlook difficult to fault.

Burson was established in Victoria in 1971 and has grown store numbers to 114. It plans to increase the network to 175 over the next five years. The Australian after-market parts industry is fragmented, with over 1,000 independent distributors, and it should continue to rationalise and consolidate, in UBS' view. The market is dominated by Repco and Burson but there is a long tail of one-shop operations. UBS beleives risks for Burson lie with stronger competitors, which are likely to use their scale to ramp up the development of private label offerings.
 

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