article 3 months old

Treasure Chest: AP Eagers Empowered

Treasure Chest | Sep 25 2019

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

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. The combination of AP Eagers and Automotive Holdings is now assured and, in reviewing the outlook, brokers find the merger compelling.

-Structural factors detracting from the industry have played out
-Options to further consolidate the sector amid likely capital management
-Opportunity to expand penetration of vehicle finance

 

By Eva Brocklehurst

The way is now clear for AP Eagers ((APE)) to drive prospective synergies after scooping up Automotive Holdings, and the merged group will be a formidable operator in Australia's car dealership space.

The merger was always considered a sound strategic fit from a geographical point of view, because this enabled AP Eagers to immediately obtain a significant footprint in Western Australia, as well as the Sydney market where it had only one site previously. The proposed new name is Eagers Automotive Group, represented in each state and territory of Australia, bar ACT, and in New Zealand.

The merger is both strategically and financially compelling, in Macquarie's view, as headwinds that plagued the industry recently are observed to be ebbing. Credit availability appears to have been the main driver of the current down cycle, where new car sales have been in decline for 17 consecutive months.

The car dealership industry has been affected by uncertainty and re-regulation stemming from the ASIC review and recommendations from the Royal Commission into the financial services industry.

Macquarie suggests growth in house prices should now support demand, conforming with normal trends, and assumes a gradual recovery in used car sales. In sum, structural factors detracting from the industry are likely to have played out, while dealership profitability has been re-based following the regulatory changes.

After the settling of the property sales recently announced by AP Eagers combined net corporate debt will fall to $271m, Morgans assesses. Moreover, after the likely divestment of the Automotive Holdings refrigerated logistics division as well as synergy costs and tax on recent divestments, the broker calculates net debt may be closer to $150m by end of 2020.

Morgans takes refrigerated logistics out of its forecasts and assumes this is sold in 2020 for $150m. AP Eagers will then have options to further consolidate the car dealership industry and/or embark on capital management. The broker considers the latter more likely.

Macquarie, too, suspects capital management is probable, as the asset sales being targeted imply over $380m in proceeds, although industry consolidation is expected to continue and the stronger balance sheet means AP Eagers is well positioned for either. The automotive industry remains highly fragmented, with the broker noting there are around 1500 dealership owner groups spread across Australia of varying sizes and structures.

The combined entity would have a market capitalisation of $3.5bn based on the AP Eagers closing price of September 20 and approximately 11.9% of the Australian new vehicles market. The combined portfolio represents 242 new car and 69 truck/bus sites.

Synergies

The company anticipates $30m per annum in synergies within the first 12 months with the initial focus on duplicated cost structures and middle management. Further afield, sourcing, funding and back-end services as well as the rationalisation of underperforming businesses will be reviewed.

Cost reductions are likely to be significant, as management believes around 30% of operating costs can be removed. Morgans estimates there could be as much as $123m in synergies, although assumes just $90m over five years, underpinned by the rationalisation of staff, a reduction in average employee wages and improved bailment (contract to transfer purchases) rates for Automotive Holdings post merger.

This quantum excludes any upside from selling underperforming businesses or more favourable lease renewals. One stumbling block, Macquarie points out, is the lease tenure of Automotive Holdings, which signals consolidation will not be immediate.

Automotive Finance

Macquarie also notes an opportunity to offset the changes to finance and insurance income from regulatory impositions such as the capping of add-on commissions. The opportunity comes from growth in the penetration of finance for new vehicles. More than 90% of Australian vehicle sales are purchased on finance, suggesting the opportunity for further market penetration by AP Eagers is significant.

However, as a cautionary note, the broker notes that around one third of vehicle sales in Australia are typically financed via mortgage/home loan-related facilities, which may encounter more challenges in converting to dealer-arranged financing.

Management believes that achieving finance penetration of around 41% would offset the recent changes imposed by ASIC but has delayed its initial target of achieving 50% by 2019, given market conditions. On a medium-term view management remains confident in achieving a 80% penetration rate in finance by 2022.

While there is a risk that ASIC may place a cap on margins for extended warranties, feedback suggests to Macquarie this is probably immaterial for the group. The broker remains confident, given management's track record in executing on synergies and positioning its business to adapt to an evolving environment.

Macquarie initiates coverage of AP Eagers with a Outperform rating and $15.60 target and ceases coverage of Automotive Holdings. While the share price has run up heavily in anticipation of the merger and expected accretion, Morgans suggests there are still plenty of catalysts over the next 12 months. Morgans has also absorbed Automotive Holdings into its forecasts, resulting in an increase in its target to $15.55 from $12.56.

The consensus target on the FNArena database at this point is $13.89, signalling 2.1% upside to the last share price. Targets range from $12.50 (Ord Minnett, still to factor in the merger) to $15.60 (Macquarie). There are five Buy ratings.

See also, Merger Dominates Outlook For AP Eagers on September 2 2019

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms

CHARTS

APE

For more info SHARE ANALYSIS: APE - EAGERS AUTOMOTIVE LIMITED