Confidence Increases In GUD Holdings

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While freight rates are a looming issue, GUD Holdings is confident price increases can be implemented, and a solid inventory position provides support

-Modest growth in first quarter considered a good sign for FY22
-GUD Holdings flags increased cost pressures stemming from freight, FX
-Is the stock cheap at a -30% discount to the S&P/ASX Small Industrials?
 

By Eva Brocklehurst

Despite the lockdowns, the GUD Holdings ((GUD)) automotive business has performed during the first quarter of FY22, benefiting from solid inventory and delivering revenue growth.

The "modest" organic revenue growth in the automotive business is cycling 16% growth from a year ago, which eventuated during a material reduction in pandemic-related restrictions, Ord Minnett points out.

Growth is attributed to some recovery in mobility, gains in market share and the company's competence in managing its supply chain. Water revenue was also up strongly as were exports from the Davey division. Citi welcomes the trends in Davey, suspecting its forecasts for first half sales growth of 3% could prove conservative, albeit Davey represents just 6% of FY22 earnings (EBIT) forecasts.

Cost pressures are occurring both domestically and internationally and freight rates could impact margins in the second half yet management is satisfied that price increases for the small automotive business being implemented in the second quarter will be enough.

A second round of price increases is in train for the larger automotive business to cover the costs that are stemming from FX and freight in the second half. A further review will be provided at the AGM on October 29.

Citi is particularly interested in further guidance at the AGM around the extent of the phasing of price increases and where supply chain pressures exist once any benefits from FX wear off.

Achieving price increases in the larger business is not without risk, Ord Minnett asserts, yet there are reasons why these can stick, given this has been well flagged to the customer base. Moreover, GUD Holdings has scale advantage compared with some of its smaller competitors.

UBS, too, is confident GUD Holdings can offset cost inflation and expects conditions should strengthen, particularly amid re-opening of Australia's east coast and the likely surge in demand for mechanics and servicing.

The broker expects the headwinds to earnings, estimated at around -$22m in FY22, that are coming from supplier price increases and freight rates can be offset by price increases of around 4% from September.

The supply chain is difficult to manage and shipping lead times are worsening, UBS notes, which will be compounded by manufacturing disruptions in China. Nevertheless, the broker is comfortable with FY22 earnings expectations and considers the valuation undemanding.

Wilsons is encouraged by the update for both the automotive and water businesses while the growth in sales compares favourably to forecasts for the first half where a modest decline is anticipated.

The broker acknowledges FY22 sales forecasts for water, at growth of 7%, could be conservative based on management's latest remarks and currently estimates a first half EBIT margin of 16.6% and EBIT of $109m for FY22.

Citi notes, following the recent decline in the share price, the forward PE ratio is now at a -29% discount to Bapcor ((BAP)), significantly above the long-run average of -10%. The broker considers this relative discount excessive.

There is a higher dividend yield associated with the GUD Holdings stock and demand from workshops is likely to recover faster compared with retail demand, given the non-discretionary nature of car servicing. The broker also suspects the company could be in a position to undertake an acquisition.

Ord Minnett upgrades to Buy from Hold, assessing the risk/reward is more balanced, and noting the stock is now trading at a -30% discount to the S&P/ASX Small Industrials as well as key customer Bapcor.

The broker suspects the market is concerned about the cycling of a strong first quarter and the lack of quantitative guidance, but argues the share price more than reflects the risk. Moreover, there is a long track record of free cash flow generation.

Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, upgraded to Overweight recently and has a target of $11.80. The database has five Buy ratings with a consensus target of $12.81 that signals 21.4% upside to the last share price. The dividend yield on FY22 and FY23 forecasts is 5.6% and 5.8%, respectively.

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