AP Eagers’ Road Not So Smooth

This story features EAGERS AUTOMOTIVE LIMITED. For more info SHARE ANALYSIS: APE

Car dealership conglomerate AP Eagers has enjoyed a welcome bounce back in sales but brokers are not that positive on the outlook ahead.

-Swift turnaround sector dynamics reverses May profit warning
-Brokers question a possible one-off impact from SME tax incentive
-Maybe rising mortgage rates are the biggest risk?

By Greg Peel

Australia’s car dealerships began 2017 with a rosy outlook but the mood soured when sales started falling away in March and April. This prompted AP Eagers ((APE)) to issue a profit warning in May, downgrading first half 2017 profit guidance to an expected -7-9% drop on the same period last year. The share price suffered as a result.

Automotive Holdings ((AHG)) has been another company suffering the same malaise, and the same share price trajectory, having been hot property not so long ago.

The good news is that car sales unexpectedly rebounded in May and June. As you were, said AP Eager’s yesterday, we now expect first half profit to be flat on the previous first half.

Four FNArena database brokers cover AP Eagers and the three that have updated on the announcement so far are pleased with the rebound in sales. Earnings forecast upgrades have followed and the consensus target price on the database has risen to $8.04 from $7.84. But as to the outlook for sales from here, the story is not so inspiring.

One-Off Tax Impact?

Morgans remains the most upbeat. The broker suggests increased sales towards the end of the financial year likely reflect another year of the government’s small business tax incentive but this was the case last year too and hence AP Eagers is cycling already solid comparables. It is also likely the rebound in profit expectations reflects lower bonus hurdles for dealerships given weaker prior sales, Morgans believes, increasing margins.

If June sales are tax related then one might expect a lull in July as everyone who intended to buy did so ahead of end of financial year, but history shows a solid June usually implies a solid July as well, Morgans notes. The other point to note is the company is working operational improvements that should reduce costs and the broker believes further material cost productivity improvement can be extracted from here.

The only issue is the stock has now rebounded 20% from its May low to what Morgans sees as around fair value, hence a Hold rating retained.

Most broker notes include as standard a list of risks to forecasts. Morgans’ note cites risks as including possible regulatory changes, slowing vehicle sales and higher interest rates.

To wit, Ord Minnett is pleased with improved sales but patchiness and consumer headwinds imply uncertainty in the sales outlook ahead, the broker believes. The other main issue for the broker is both AP Eagers and Auto Holdings have driven growth through acquisitions, to the point new acquisition opportunities are becoming thinner on the ground and competition will push up required purchase prices.

Ord Minnett also retains Hold.

Risk From Rising Mortgage Rates

Morgan Stanley agrees it will be tough for both companies to execute on substantial acquisitions in the near term which have been a key driver of growth. The broker also queries the implications of AP Eagers’ rebound in profit expectation given that by the broker’s calculation, sales are actually down -8% on new guidance when one adds in the contributions from new acquisitions over the period.

Most clouding the outlook however, as far as Morgan Stanley is concerned, are rising mortgage rates. While it makes sense that rising household debt costs would make a consumer think twice about buying a new car, the broker’s research has indeed found a very strong inverse correlation between new car sales and mortgage rates.

Then there is the attention ASIC is now paying to the industry, focusing on responsible lending and subsequently risking lower volumes and commissions if regulatory changes are made.

Put this together and of the three brokers, Morgan Stanley is the least optimistic, as reflected in the broker’s unchanged Underweight rating.

The fourth broker, Credit Suisse, has a Neutral rating.

While all of the issues cited above also apply to Automotive Holdings, Ord Minnett sums up broker perceptions in suggesting the company has more “self-help” opportunities to exploit, particularly in the struggling logistics business which is separate to the car business.

To that end, by comparison Auto Holdings boasts four Buy (or equivalent) ratings from seven covering brokers with two Holds and one Sell, to AP Eagers’ three Holds and one Sell.
 

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