Automotive Holdings Better Off Without Logistics

This story features EAGERS AUTOMOTIVE LIMITED. For more info SHARE ANALYSIS: APE

-No meaningful synergies
-Slower growth in logistics
-Value unlocked if divested
 

By Eva Brocklehurst

Automotive Holdings ((AHG)) has underperformed over 2016 against both the Small Ordinaries index and its major listed peer, AP Eagers ((APE)). Several brokers blame the poor performance on the company's refrigerated logistics business, which has dragged down a robust automotive retailing division.

Refrigerated logistics has been a significant source of both broker and investor disappointment over recent years, failing to achieve management's targets. To brokers there are no meaningful synergies to be derived between the two divisions. Conditions over the second half in logistics have deteriorated and the company remains part way through an operational review.

Ord Minnett contends that capital intensity, poor returns and earnings volatility in the logistics business has affected investor sentiment. On a like-for-like basis, and valuing the automotive retailing at a conservative 20% discount to AP Eagers, the broker calculates that the market is attributing zero value to Automotive Holdings' other businesses.

Ord Minnett believes pressure is mounting on the board to do something and undertake an accretive transaction. An in specie distribution to divest the logistics business is considered the best way to go. The broker believes an outright sale would bring capital into the company but there is a risk that capital losses could be trapped within the group.

On the other hand, an in specie distribution would lead to much greater shareholder value creation. Both entities are likely to attract a level of corporate appeal, Ord Minnett adds. The broker's analysis of de-mergers in Australia over the last 15 years indicates that de-merged entities, on average, outperform the broader market by around 10 percentage points per annum over the subsequent two years.

Macquarie calculates Automotive Holdings generated 70% of first half earnings from the automotive dealership. There has been regulatory concerns over future commission payments but, offsetting this, the broker contends there is a large opportunity in the second hand vehicle market. The stock looks oversold too, on both regulatory fears and the logistics outlook.

Macquarie substitutes AP Eagers' FY17 automotive multiple in its AHG valuation and calculates a share price target of $6.89 suggesting, to achieve this multiple, the logistics business would need to improve considerably.

The broker has lowered forecasts for logistics in recognition of a slowing economy and lower growth from the major food retailers while estimates for the automotive division are unchanged. Moreover, the underlying assumption of no organic growth in FY17 makes allowance for any revenue and margin pressure from the outcome of the Australian Securities and Investments Commission review.

At the company's first half results it disclosed that ASIC is reviewing finance and insurance revenues in the automotive dealer industry, looking at commissions on consumer finance to ensure a fair outcome for consumers.

FY16 is likely to deliver a disappointing result, magnified by the opportunity cost of a misallocation of capital, in Deutsche Bank's view. The broker agrees the market's disappointment is warranted and predicts logistics earnings in FY16 of $39m, approximately 40% below the projected earnings base from two years ago.

The company has invested $311m in capital into this business since FY10. Had the capital been invested into automotive, Deutsche Bank maintains earnings in FY16 could have been 29% higher than forecasts currently suggest. This broker also expects significant value can be unlocked by the divestment of logistics but considers the probability highly uncertain, although it would be a major catalyst for the stock.

If the company chooses to divest the logistics business for around $150-250m – it has indicated it is open to offers – and redeploy the capital to automotive, the broker expects it would be accretive by 9-21%.

The operational review and any benefits forthcoming are likely to take longer to realise than first anticipated, Deutsche Bank maintains. Moreover, it will overshadow a very good automotive result. The broker notes Australian new vehicle sales have been strong over the first five months of 2016, with year-to-date sales in May up 3.8%. While the risk/reward proposition remains favourable, the broker retains a Buy rating.

FNArena's database has three Buy ratings and three Hold. The consensus target is $4.40, suggesting 14.3% upside to the last share price. The dividend yield on FY16 and FY17 forecasts is 5.9% and 6.3% respectively.
 

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