Australia | Nov 24 2017
Brokers welcome the news that Automotive Holdings has finally offloaded its refrigerated logistics business, a division that has been a drag on the company for several years.
-Now well able to fund growth in the higher-value automotive sector
-FY18 earnings outlook hinges on timing of sale completion
-Cost reduction initiatives should offset pressure on commissions
By Eva Brocklehurst
Automotive Holdings ((AHG)) has transformed into a pure automotive player after finally divesting its refrigerated logistics business. Refrigerated logistics was a drag on the company and brokers consider the divestment at a price broadly in line with book value is a positive outcome.
Refrigerated logistics has been sold for $400m to HNA Group, a Chinese conglomerate. The consideration comprises both cash and the assumption of $120m in finance lease liabilities.
Outside of the financial impacts of the sale, UBS believes a key benefit is the reduced time management will allocate to the division, one that made up around 10% of operating EBIT. Management can now be better occupied in consolidating the automotive business, and adapting both new and used car models in response to changing consumer behaviour and industry pressures.
Moelis marginally reduces operating earnings estimates for FY18, reflecting an assumed divestment of the refrigerated logistics division during the third quarter.
Given the ability of the company to redeploy capital into the more profitable automotive business or make returns to shareholders the broker believes the remaining division deserves to trade at a higher price/earnings ratio of around 14x. As a result the target price moves up to $4.05. Moelis, not one of the eight monitored daily on the FNArena database, retains a Buy rating.
The transaction should be completed by March but, because of the seasonality of the business, Morgans forecasts refrigerated logistics will still make an 87% contribution in FY18 to overall earnings. In the first four months of FY18 automotive earnings declined -10.6% and group operating earnings (EBITDA) of $59.7m was down -4.8%. Operating net profit only declined by -3.1%, because of higher depreciation & amortisation.
Following the disclosure, Morgans reduces forecasts for FY18. The company did not explicitly confirm guidance for profit growth in FY18, rather stated that its outlook is dependent on timing of the completed sale of refrigerated logistics. The divestment may not be accretive on a standalone basis but Morgans believes the company is now well able to fund further growth in the higher-value automotive segment.
Use Of Proceeds
The sale is a game changer in Morgan Stanley's opinion, providing valuation support and capacity for acquisitions and/or a special dividend. The broker believes the focus now returns to growth in the business and this is not reflected in the share price, upgrading to Overweight from Underweight.
UBS agrees there is a more certain earnings profile now although, while trading at a relatively undemanding multiple, would like underlying growth in the business to be evident before taking a more positive view. Hence, UBS maintains a Neutral rating.
Morgans expects the proceeds to be put towards debt reduction and potential capital management initially, but believes a key attraction is now the ability to pursue retail acquisitions in the automotive space. The sale releases meaningful capital and reduces expenditure from a servicing aspect as well. Moelis envisages potential to ramp up the rolling out of the easyauto123 used car strategy.
Car Sales Outlook
UBS points out the company previously suggested that insurance regulatory changes will lead to a -10% fall in operating earnings and this implies no like-for-like growth. Vfacts data out of Western Australia has shown that three out of the last six months are positive, after more than four years of negative data. However, the timing of registrations does not always line up with private car sales and WA is not yet contributing to growth for the company.
The decline in the company's operating earnings over the four months is greater than Moelis expected, yet there is normally a lag between business and consumer sales and, when the consumer market in WA starts to turn around, the company should benefit.
Despite being better placed to source opportunities UBS does not expect Australian new car sales will drive growth in FY18. The broker points to recent soft data including weak household cash-flow modelling. Positive trends such as low interest rates and affordable financing options appear to be outweighed by macro weakness, and there is a risk new car sales weaken in FY18, with UBS forecasting a fall of -1.2%.
Insurance margins are also unlikely to rise to 4%, in the broker's opinion. Incremental improvements are expected each year, as the company benefits from scale and cost reductions, but margins are expected to settle in the 3.5-4.0% range.
Morgan Stanley accepts the automotive division has had a difficult four months to November but remains confident of a second half improvement, as the worst appears to have passed in WA. Excessive clearance and rebate targets had a -$12m impact on FY17 earnings and this presents a low base to work from. Cost reduction initiatives should also offset the downward pressure on commissions resulting from regulatory changes.
Nevertheless, the broker takes a conservative stance and lowers estimates by -5.9% for FY18 and -3.7% for FY19. While a delay in the turnaround in automotive business is a key risk Morgan Stanley believes the difficult environment has been factored into the stock.
FNArena's database shows six Buy ratings and one Hold (UBS). The consensus target is $3.78, signalling -0.2% downside to the last share price. This compares with $3.51 ahead of the update. The dividend yield on FY18 and FY19 forecasts is 5.0% and 5.3% respectively.
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