Caution Uppermost For GUD Holdings

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Weaker economic conditions and increased competition look like hampering automotive and water product distributor GUD Holdings in the year ahead.

-Aftermarket service and supply slowdown accelerated in the fourth quarter of FY19
-Preferred supplier arrangements in place to limit market share losses
-Accretive acquisitions the main potential for upside
 

By Eva Brocklehurst

A softer outlook for the automotive division meant brokers were disappointed with the FY19 results from GUD Holdings ((GUD)). Management has highlighted a number of issues, such as weaker economic conditions, increased competition and a failure to cut through significantly with the launch of the new catalogue.

Activity in the aftermarket service and repair industry has been sluggish and trade customers appear hesitant to spend. Moreover, new entrants in the market, particularly in the filtration category, have put pressure on industry margins.

The company has guided to modest growth in FY20 but brokers are becoming increasingly cautious. Several have downgraded their ratings, Macquarie and Citi to Neutral, and UBS to Sell from Buy. UBS believes the company – share price has been on a downward trend since May – will find it difficult to grow earnings (EBIT) in FY20.

Citi sums up the outlook as involving too much short-term uncertainty. The broker considers the FY19 results was a story of two halves. The first half was "reasonable" while the second half slowdown accelerated in the fourth quarter, leaving little confidence in a definitive turnaround in the first half of FY20.

Macquarie suspects FY20 is likely to be a year of consolidation and only modest earnings growth. Under new management, GUD Holdings has stopped giving a definitive earnings guidance range but has flagged re-seller softness, which affected second half sales but also resulted in unintended accumulation of inventory, in turn affecting working capital.

The launch of the Narva catalogue was disappointing for UBS, as industry feedback has signalled weaker sales. The broker was surprised that organic revenue declined in the automotive segment, given its recent history of firm gains, although a potential catalyst for upside could be accretive acquisitions.

This is the area where Macquarie was most disappointed as there were no acquisitions over FY19. The broker's forecast had assumed $20m in automotive acquisitions would support FY20 and FY21. Removing these factors drives a -50% revision to estimates.

The broker assesses, while the automotive division is an attractive asset, it will take time to recover. UBS forecasts long-term automotive earnings margins of around 23% and agrees that, while automotive division remains defensive, as a result of expansion of major automotive parts distributors in the trade channel and low single-digit price increases, only modest top-line growth is likely to be achieved.

Competition

Moreover, current margins are unlikely to be sustainable over the next 3-5 years in the automotive division. The company, UBS notes, has a high market share and an imported brand consumer business and is also expanding its customer base. Yet the perpetual threat of private-label competition and the move away from internal combustion engine parts will reduce margins over the longer term.

UBS also envisages risks emerging in the form of supply-chain consolidation amid difficulty in generating price increases. Preferred supplier arrangements are now in place across several major customers to limit potential market share losses but Macquarie points out there were no details regarding any potential impact on margins.

Moreover, acknowledging the competitive environment, the company's Ryco brand did not implement price increases. This is a key aspect to the substantial FX headwinds that the company faces over FY20, UBS suggests. The broker calculates that in FY20 the failure to increase prices will affect earnings by around -$4.6m.

While not overplaying Mann's entry into the market, the broker believes it remains a risk as does private-label penetration across all the company's categories. UBS suspects weaker volumes versus history could be an ongoing theme over the next five years as customers rationalise warehouses.

Preferred supplier arrangements are now in place across several major customers to limit potential market share losses but Macquarie notes no details were provided regarding any potential impact on margins.

Competitive threats and the dominance of a handful of channel partners will continue to be important, although Ord Minnett believes this is now adequately priced into the earnings multiple the stock. On the positive side Davey improved in the second half with revenue growth in all regions, despite a continuation of drought conditions, as new products and growth initiatives came into play.

Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, suggests relative value is emerging in the stock and the dividend yield remains attractive.

The broker has become increasingly concerned about the organic earnings growth prospects and the erosion of the elevated margins in the key filtration category. Hence, the outlook commentary has validated concerns and a Hold rating is maintained with a $10.25 target.

The database has one Buy (Ord Minnett), three Hold and one Sell (UBS). The consensus target is $10.66, signalling 5.6% upside to the last share price. This compares with $13.28 ahead of the results.Targets range from $9.50 to $12.00. The dividend yield on FY20 and FY21 forecasts is 5.7% and 6.0% respectively.

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