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Treasure Chest: Are AP Eagers And Automotive Holdings Offering Value?

Treasure Chest | Oct 10 2016


Moelis believes the downside from the ASIC review has now been factored into AP Eagers and Automotive Holdings.

By Eva Brocklehurst

AP Eagers ((APE)) and Automotive Holdings ((AHE)) have experienced a sharp decline in share prices, with market concerns centring on a review by ASIC (Australian Securities and Investments Commission) into motor dealer finance income.

ASIC's review of add-on insurance products released in September contained a proposal for a 20% cap on dealership commissions. The sale of these products previously attracted higher margins. Moelis expects the impact of an add-on insurance cap of 20% on such commissions is likely to be offset by management initiatives for a net impact of negative 1% of EBIT (earnings before interest and tax) for both companies.

ASIC has not stated anything publicly, but in terms of the expected outcomes of the finance review to be announced later in the year, using a 1.5% cap on flex commissions Moelis expects the gross EBIT impact will be in the order of 20% and 14% for Automotive Holdings and AP Eagers respectively.

With some downside mitigation by management, the broker would not rule out a net 10% negative EBIT impact for Automotive Holdings and a 5% negative impact for AP Eagers from a cap on flex commissions.

The broker understands dealers receive finance income from several sources, including around $600 in origination fees per car, a volume bonus paid by the financier and a flex commission, which is around a 70% share in the upside from writing interest rates above a base rate of 5%. The latter area is where ASIC is expected to intervene with a cap on commissions.

The broker notes there are some independent players in the market that are over-earning on flex commissions and these dealerships are likely to be the ones most affected by a 1.5% cap. The large listed dealerships are expected to pick up volumes from these independents.

Moelis also understands both companies have strategies in place to mitigate some of the downside, including lower levels of discounting in the sale price of vehicles, different remuneration structures with the financier and reduced sales staff remuneration.

To achieve an earnings-per-share neutral impact, Automotive Holdings would need to increase market penetration to 53% from its current 42% and AP Eagers to 43% from 38%.

Even adjusting for the impact of these caps on commissions the broker believes AP Eagers' core business is trading below a market multiple. Given the company can deliver a FY15-25 compound growth rate in earnings per share of over 10%, after adjusting for the impact of finance and insurance commission caps, the broker believes the business deserve to trade at a premium to the market.

Automotive Holdings looks cheap too. With increased exposure to Western Australia and lower growth potential through consolidation, Moelis believes the stock deserves to trade at around a 5% discount to AP Eagers' current multiple.

The broker believes the downside is now factored in and, while not including the impact of the ASIC review in earnings estimates, includes it in its valuation of the stocks. On this basis the broker moves to a Buy rating for both, with a $13.30 and $4.80 target for AP Eagers and Automotive Holdings respectively.

Moelis also notes the opening of the first Carzoos store by AP Eagers last month and is impressed with the location. The broker is increasingly confident in the concept.

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