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Significant Opportunity Awaits Car Retailers

Australia | Aug 09 2016


Significant opportunity awaits Automotive Holdings and AP Eagers if they can successfully clear several near-term obstacles, brokers suggest.

-Strength in car retailing offers acquisition potential for APE, AHG
-APE's Carzoos considered an attractive, supportive proposition
-Automobile segment eclipses negatives for AHG's refrigerated logistics

By Eva Brocklehurst

There is a significant opportunity for consolidation in the automotive industry, given a large and fragmented market. Moreover, UBS contends, 2016 is likely to be a record for the automotive retailing industry in Australia, with sales of new and used cars travelling well in 2016.

Of note, there are two significant issues to be negotiated for the sector’s key operators. The first is the Australian securities and Investments Commission (ASIC) investigation into dealer finance income.

Moelis suspects this could lead to a reduction in finance earnings and hit the income of Automotive Holdings ((AHG)) and AP Eagers ((APE)) by 20% and 14% respectively, if there is no corrective action from management. ASIC has proposed abolishing flex commissions above the base rate. While management may be able to counter some of the impact, the broker still expects some downside to earnings.

The other headwind is the changing consumer attitude towards car ownership, with new vehicle sales potentially slowing to 1.5-2% growth per annum from 2.5-3%. Moelis observes that as ride sharing models increase in popularity, the car/ride sharing component could comprise 10% of a total car park and potentially involve a higher proportion of total rides.

The broker quotes research which indicates every shared vehicle replaces ten vehicles previously purchased while the traditional replacement cycle is ten years. Hence, the expectation that new vehicle sales could slow to the above rate.

Aside from these headwinds, Moelis believes AP Eagers and Automotive Holdings are well placed to make acquisitions, as both have an ability to negotiate a lower cost of debt and move excess inventory across their dealer network.

The broker, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Hold rating on AP Eagers, with a $13.28 target, believing the stock is a well capitalised long-term growth story with the means to make $67m in acquisitions through cash flow, supplemented by a corporate debt facility.

The company’s Carzoos used vehicle sale/purchase concept, with extended warranty and capped price servicing to all customers, could also increase customer retention, the broker maintains, and there are low operating costs and little up-front capex required.

The broker believes Automotive Holdings is priced for underperformance, but maintains a Hold rating and $4.70 target given the weakness in WA and the uncertainty around the ASIC inquiry.

Moelis does not expect management will sell the refrigerated logistics business in the near term and if it were sold, this would lead to a purer business and warrant a higher market multiple. Furthermore, the sale could provide sufficient capital to pursue an acquisition strategy similar to AP Eagers, allowing Automotive Holdings to move to a 10% market share by 2025.

UBS suspects it might be time to buy Automotive Holdings. New car sales have continued to grow, with UBS noting growth has been driven by increasing affordability and rising wealth, a function of lower price points, low interest rates and affordable financing options. As the largest automotive retailer in Australia the company is expected to benefit, with organic growth supplemented by acquisitions.

The stock has underperformed the Small Ordinaries index by 20% over the past 12 month as its refrigerated logistics division is expected to reveal a decline in earnings over FY16, because of increased competition and customer in-sourcing.

This division is unlikely to deliver a positive return on assets over the weighted average cost of capital, but with momentum in the automobile segment likely to continue any improvement in refrigerated logistics would be well received, UBS maintains. The broker upgrades the stock to Buy from Neutral.

FNArena’s database contains five Buy ratings and two Hold for AHG, with a consensus target of $4.44 suggesting 2.1% upside to the last share price. Targets range from $4.34 (Ord Minnett) to $4.63 (UBS). The dividend yield on FY16 and FY17 forecasts is 5.2% and 5.5% respectively.

There are two Buy ratings and two Hold for APE. The consensus target is $11.86, suggesting 1.5% downside to the last share price. Targets range from $10.89 (Ord Minnett) to $13.00 (Credit Suisse).

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