Execution Remains Key For GUD

This story features G.U.D. HOLDINGS LIMITED. For more info SHARE ANALYSIS: GUD

-Turnaround provides buying opportunity
-Competitive market means risks are high
-Defensive stock, attractive dividend yield
 

By Eva Brocklehurst

Industrial and consumer product conglomerate, G.U.D. Holdings ((GUD)), delivered an FY14 result that perplexed the market. Underlying earnings were ahead of forecasts but restructuring costs were greater and this weighed on cash flow and market sentiment. Key to the outlook is management's expectation of $10m in annual benefits to flow from restructuring and profit improvement programs and, should this materialise, GUD could be a candidate for a review of ratings, in CIMB's opinion.

CIMB accepts there is some uncertainty about whether management can execute on its ambitious growth targets but if it does, the consequence is trading earnings that are materially higher than the market currently implies. The broker thinks the stock weakness is a buying opportunity based on a turnaround story. Sunbeam's (consumer products) results were particularly troublesome. Maybe the warm winter did away with the need for electric blankets. CIMB suspects that a flat sales outlook is a reasonable starting forecast for Sunbeam in FY15, but the momentum in the other businesses provides the confidence that cost savings will not be countered by falling revenue. For the Dexion (storage solutions) business CIMB thinks the light at the end of the tunnel is beginning to show, with a strong order book of $69m going into FY15.

Some confusion around currency benefits probably masked the positives, on CIMB's calculation. The company is obliged to report cost of goods sold (COGS) based on spot rates, rather than at the rate locked in by hedging. This is then offset to neutralise the impact at the earnings level. This may have alarmed some investors but the broker believes there is no cause for that. The FY14 one-off FX gain was offset by an artificial increase in COGS, because of accounting standards. The final dividend of 18c was lower than the 21c CIMB expected. The broker suspects the business is moving to a more sustainable pay-out ratio at around 80%. A restructuring provision of $13.3m, mainly related to the closure of the Dexion plant at Kings Park, probably represents the conclusion of the restructuring provisions but CIMB expects a trailing $8m in cash outflow in FY15.

Automotive products (Ryco, Wesfil, Goss) achieved all-time high margins and profitability and this highlights its reliability. Citi emphasises that this division is essential to the company's earnings, given it contributed 54% in FY14. Key questions for the broker in FY15 are whether the company does maintain its strong margin for automotive and whether the contraction in Sunbeam and Dexion margins can be stemmed. UBS believes a lot of the upside to earnings is already factored in and retains a Sell rating. Moreover, one-offs have been a consistent feature recently and the broker is wary that any normalisation of earnings in FY15 is not guaranteed to generate a corresponding rise in free cash flow. That said, the broker recognises management is making the necessary changes to improve prospects and the stock does have defensive aspects together with an attractive yield.

Credit Suisse is more optimistic. In fact, this broker thinks the market is plain wrong in perceiving the results as low quality. Operating cash flow was ahead of forecasts and, as CIMB pointed out, a $4.5m FX gain was offset by COGS. Credit Suisse also notes a $1.1m reduction in the employee benefits provision, related to a resignation pay-out for the former CEO. This provision was raised in FY13 and paid out in FY14.

Numbers aside, the broker thinks the more important aspect is that the turnaround is progressing well. Credit Suisse also thinks the pullback in the share price is a buying opportunity. Dexion is a key positive business, standing out with a good second half performance. Dexion offers not only the lowest relative risk in terms of achieving restructuring benefits but also strong demand and expanding product. Sunbeam has the most risky trajectory, based on the extent and timing of further sales decline, but Credit Suisse notes management remains fairly positive, implying a bottoming in revenue with some modest market share gains. Improvement should flow into FY15 as the division benefits from logistics initiatives.

Demonstrable profit improvement is necessary for JP Morgan. Sunbeam disappointed the broker while Davey (water products) surprised on the upside. The improvement programs for Dexion, Sunbeam, Davey and Oates (consumer products) are all expected to generate a $30m earnings uplift. Coupled with earnings from the new Dexion plant in Malaysia, this implies FY17 earnings of $79.4m. JP Morgan observes GUD has not generated that level of earnings since FY05, and the market is now more competitive. The broker has erred on the side of caution and forecasts FY17 to be well below that level at $63.0m. Moreover, the broker does not think cash conversion will be as strong as it used to be. This fell to 60% in FY14 from the historical average of 97%, because of growth in debtors, changes in trading terms and the extension of payments in tight economic conditions. All up, the signs are encouraging but the broker wants to wait and see.

Goldman Sachs sums up the outlook thus: GUD's valuation would appear attractive, given a FY15 price/earnings ratio of 13.3 times and dividend yield of 6%, but the turnaround strategy has high execution risks as a result of weak consumer markets, strong competition and cost pressure. The broker retains a Neutral rating.

On FNArena's database broker ratings run the gamut. There are two Buy ratings, two Hold and one Sell. The consensus target is $6.61, suggesting 3.4% downside to the last share price, and compares with $5.99 ahead of the results. The dividend yield is 6.3% and 6.9% for FY15 and FY16 respectively.

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