Australia | Aug 01 2018
Cash conversion was strong at GUD Holdings in FY18 and brokers highlight the potential for the company to consolidate its position in the automotive segment.
-Potential downside risk to automotive margins
-Is GUD positioning to divest Davey?
-Substantial capacity for further acquisitions
By Eva Brocklehurst
Organic growth and bolt-on acquisitions in the automotive segment should underpin GUD Holdings ((GUD)) in FY19. Cash flow was the highlight of FY18, as second half cash conversion lifted to 89%.
Substantial balance-sheet capacity and further cash generation are expected to support potential acquisitions. Automotive revenue growth was 16% in FY18 and organic growth improved to 9% from 8% in the first half.
Ord Minnett believes the company is positioning to divest Davey Pumps, as the new CEO's prior role was with Ford Australia, and the company has previously been busy divesting businesses and focusing on automotive. Around $6m in write-offs have been taken in the Davey business which should assist future EBIT (operating earnings) margins.
A transaction would be considered positive by the market, in the broker's view, because of benign growth at Davey and the more attractive opportunities available in automotive. Nevertheless, Ord Minnett believes much of the re-rating the stock has already occurred.
A divestment of Davey, the last remaining business outside of the automotive segment, could generate around $80m or more, in Macquarie's calculations, and drive 19% compound growth to EPS in FY18-21. The broker finds the stock valuation undemanding given the quality of the business and growth outlook.
Margins
Citi expects the stock will also be supported by margin expansion from synergies and scale benefits and believes the 20.4x PE implied in its target is justified, given the company's consistency and the resilience of organic growth.
FY18 earnings missed estimates, largely because of margins, and UBS takes a cautious view regarding the long-term profile for the automotive division. That said, the broker does not expect electric vehicles to have a major impact on Australia's car industry over the next decade. Around 46% of the company's automotive sales relate to internal combustion engines and non-ICE sales typically generate lower margins, particularly against the highly regarded Ryco brand.
However, UBS believes increasing consolidation of the trade distribution channel and rising private label penetration will eventually pressure elevated automotive margins towards a long-term forecast of 24.9%, from the current 28.1%.
Credit Suisse incorporates the dilution from lower-margin acquisitions in FY19 but only assumes modest declines beyond that point although accepts, given GUD supplies large customers, downside to margins remains a potential risk.
Meanwhile, growth is considered elusive for Davey, albeit the pumps business is small in a group context. The flat result at Davey was the main reason EBIT were slightly lower overall versus the broker's expectations.
Acquisitions
Organic growth in automotive has been supported by growth in vehicle numbers over the past decade and GUD is increasing its share as major customers consolidate and the product range is expanded. Credit Suisse considers high single-digit organic growth in automotive sustainable and agrees there is substantial capacity, highlighting the company's inclination towards further acquisitions.
Citi envisages the primary drivers of the company's business are continued growth in car numbers and annual price rises, as well as a positive shift in mix to more expensive parts and new product development. The broker estimates GUD could fully fund via debt up to $90m in acquisitions before reaching the upper end of its net debt/EBITDA target range of 1.8-2.0x in FY19.
GUD is a logical consolidator of automotive brands, being an independent distributor, Macquarie suggests, and there are plenty of highly accretive acquisitions available from which significant synergies could be extracted.
FNArena's database shows two Buy and three Hold ratings. The consensus target is $14.70, suggesting 2.8% upside to the last share price. Targets range from $13.85 (UBS) to $15.50 (Citi, Macquarie). The dividend yield on FY19 and FY20 forecasts is 4.1% and 4.5% respectively.
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