GUD Holdings Better Off Without Dexion

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GUD Holdings is hampered by its Dexion division, brokers maintain, and would be better off divesting the business.

-Trade sale of Dexion considered GUD's best option
-Automotive outlook robust and increasingly important
-Although FX tailwinds easing and margins likely peaking
 

By Eva Brocklehurst

G.U.D. Holdings ((GUD)) was hampered by the performance of the Dexion storage system in FY16, while the automotive division starred and Davey pumps appears to have turned around. The company is expecting a return to growth in Oates cleaning products after the division deteriorated in the second half.

FY16 earnings fell short of broker expectations and guidance, with Dexion the main culprit. Despite the profitable June quarter at Dexion, a lack of confidence in the top line has led to a $75.7m pre-tax impairment and the initiation of a strategic review. GUD has signalled an interest in bolt-on acquisitions for automotive and Davey in the next year. The portfolio continues to shift towards automotive, which was 78% of FY16 earnings.

The automotive segment is the key reason Macquarie would own GUD. Ryco provided 10% earnings growth and Brown & Watson International (BWI) performed well in terms of margins in its first year of GUD's ownership, delivering earnings well ahead of initial expectations.

The automotive division underpins organic growth forecasts, although it is clear to the broker management is exploring acquisition opportunities. Macquarie also envisages considerable opportunity for joint promotions and cross-selling between Ryco and BWI. Management is targeting 30% earnings margins at BWI and expects growth across the automotive division to be above average over the next few years.

The ability to offload Dexion is key to the future of the company, brokers maintain. The division incurred a $3.8m earnings loss for FY16, affected by weaker commercial demand. Macquarie understands closure of the business is not an option and a sale is the preferred route in FY17. A divestment anywhere near book value ($44m) would be a great outcome, in the broker's opinion, although interest is most likely limited to other industry participants which could realise substantial synergy benefits.

Meanwhile, GUD has re-rated on the back of the Sunbeam divestment and appears fairly valued to brokers with further upside if management is successful in divesting Dexion. Ord Minnett considers the potential for further portfolio rationalisation is reduced in the near term but the company has a robust automotive division to turn to with strong cash conversion.

Dexion's high fixed cost base is exacerbating the weak order book and, in the case of Oates, price rises are required to offset FX headwinds, but the broker notes this is difficult in the current grocery and hardware setting.

While the outlook for Dexion is challenging and broader demand is soft, UBS points out this segment is now far less important to the company compared with back in FY12 when it accounted for 10% of earnings. The strategic review suggests a trade sale is an option and the recent exit from Sunbeam illustrates a willingness and ability to divest under-performing divisions.

In the meantime, the automotive division is defensive and comprises imported branded consumer businesses with high market share, although the FX tailwinds which have been a feature of recent years are easing and the broker suspects margins have peaked. UBS believes there is an opportunity for GUD to simplify, divest segments and become more of a pure play in the automotive aftermarket.

Credit Suisse believes the considerable earnings uncertainty within Dexion, in particular, counters any positive potential from mergers and acquisitions. That said, the broker also maintains that the divestment of Dexion would be a positive catalyst and remove a volatile earner that overshadows the stock, allowing capital to be redeployed more constructively.

FNArena's database has one Buy rating (Citi) and four Hold. The consensus target is $9.47, suggesting 5.3% downside to the last share price. Targets range from $8.80 (Citi) to $9.90 (Macquarie, Ord Minnett). The dividend yield on FY17 and FY18 forecasts is 4.7% and 5.2% respectively.
 

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