Acquisitions Key To GUD Holdings Outlook

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GUD Holdings posted a robust first half and brokers are largely positive on the outlook, which remains heavily premised on further automotive acquisitions.

-Ability to adapt to electric vehicle market expected to dominate attention going forward
-Well positioned to consolidate automotive brands
-Margin pressure possible in the medium term
 

By Eva Brocklehurst

Brokers suggest the growth outlook for GUD Holdings ((GUD)) is attractive, as the company consolidates the automotive aftermarket. Yet, several have lingering concerns regarding margins.

Credit Suisse agrees the growth outlook is attractive and operating condition supportive, suspecting full year results may exceed estimates, if for no other reason than no acquisitions are incorporated in its forecasts, and the company will almost certainly make some more.

Nevertheless, while valuation does not appear expensive, for Credit Suisse to engage in a re-rating requires the market to appear comfortable about the exposure to a sunset industry (internal combustion engine at 48% of revenue exposure) and the company's ability to adapt to electric vehicles. The broker expects this topic will dominate investor attention going forward.

UBS points out that management emphasised the minor impact that electric vehicles would likely have on Australia's car pool over the next decade. Moreover, automotive division sales now comprise 52% of components that are unrelated to the internal combustion engine.

Acquisitions

The company appears well-placed to acquire high-quality automotive aftermarket brands that are not too reliant on sales to either Bapcor ((BAP)) or Repco, UBS asserts. Given the company has stated it has a strong potential pipeline of acquisition opportunities, the broker acknowledges an accretive acquisition remains the main risk to its Sell rating.

Ord Minnett agrees that outside of a material acquisition, further multiple expansion or meaningful earnings upgrades are unlikely. Yet, given the industry is relatively fragmented, the broker expects more bolt-on acquisitions to be made over the year.

Macquarie upgrades to Outperform, expecting strong growth in the automotive division. GUD beat the broker's first half forecasts with strong performances across key product lines amid new products driving growth. Macquarie believes the company is uniquely positioned to further consolidate automotive brands.

This advantage versus sector peers lies in the fact that GUD does not suffer from sales leakage to competitors on acquisition. Macquarie expects GUD to further leverage its scale and distribution network for newly acquired products and deliver a mutually beneficial uplift in sales for its customers as well.

The broker's tracking of the SuperCheap Auto ((SUL)) website shows the number of  Narva & Projecta units stocked increase significantly under GUD ownership. Macquarie likes the leading market position, which consistently delivers high single digit organic growth, and suggests the discount at which the stock is trading is unjustified.

Margins

Citi expects further automotive acquisitions and margin expansion from the synergies being extracted from recent acquisitions. The broker estimates the automotive business delivered margins of 28.8%, a 10% improvement on the first half of FY17.

Credit Suisse found the cash flow conversion disappointing, while noting lower automotive operating earnings margins were ascribed to a mix of newly-acquired businesses, some of which should do better within the broader GUD group. The broker was encouraged by the improvement in costs at Davey but remains mindful of the volatile earnings in that division.

Since the AGM in late October, when management guided to $90-94m in operating earnings (EBIT) for FY18, the company has divested Oates and acquired AA Gaskets. GUD now expects earnings to be about $90m, which incorporates seven months contribution from AA Gaskets and six months from Oates.

Accounting for these adjustments, Ord Minnett estimates the new guidance is effectively based on the mid point of the original $90-$94m forecast and implies no change to the outlook.

Earnings are skewed around 90% to automotive products, a relatively defensive category UBS concedes, but with some medium-term margin pressure. UBS agrees the cash performance was poor but found it difficult to judge this, given the number of divestments and acquisitions that have been made in recent times.

UBS believes the current share price does not factor in these margin risks. The broker still suspects that increasing consolidation of the trade distribution channel and private labels will eventually pressure the elevated margins the company enjoys in automotive, although in the shorter term margins may rise as recent acquisitions are integrated and revenue synergies realised.

FNArena's database has two Buy ratings, two Hold and one Sell (UBS). The consensus target is $12.80, signalling -0.5% downside to the last share price. This compares with $12.23 ahead of the report. Targets range from $12.25 (Ord Minnett) to $13.90 (Citi). The dividend yield on FY18 and FY19 forecasts is 4.0% and 4.5% respectively.

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