Australia | Oct 02 2019
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Suncorp Group will sell two motor repair businesses to AMA Group, in a deal designed to improve utilisation of the repair shops while retaining a cost benefit.
-Agreement that Suncorp's lower costs relative to peers will be maintained
-Utilisation of the network should be improved without increasing claims costs for Suncorp
-High chance of further capital management in the second half of FY20 from Suncorp
By Eva Brocklehurst
The sale of two motor repair businesses to AMA Group ((AMA)) should make Suncorp Group ((SUN)) shareholders very happy, several brokers suggest, allowing for bumper returns in the second half of FY20. The sale includes a 90% stake in Capital SMART, valued at $420m, with Suncorp retaining 10% and a subsidiary board seat. The other divestment is ACM Parts for $20m.
Suncorp is not generating sufficient repair volumes to maximise the use of the Capital SMART shops, Citi points out. Hence, selling these to another party that can attract external customers to the underutilised facilities make strategic sense.
Moreover, the multiple looks reasonable. However, in terms of sales this is marginally negative for underlying margins as the divestment removes the business profit that was previously netted against insurance claims.
Still, by opening up the opportunity to vehicles that are not insured by Suncorp, but obtaining cost benefits in the long-term agreement, utilisation of the network can be improved without increasing claims costs for Suncorp.
Macquarie suspects only time will tell whether de-coupling from the supply chain is the best result for insurance customers and Suncorp's margins. The broker's analysis indicates that the combined business of AMA Group and Capital SMART is overweight Victoria and underweight Queensland, and will observe with interest whether this forms part of Suncorp's growth plan in motor insurance.
Owning the supply chain has been a critical reason why Suncorp's claims have outperformed industry, the broker notes. The deal has been done on the agreement that Suncorp's lower costs relative to peers will be maintained. Macquarie also understands there are no stranded costs for Suncorp post the sale. Neither will there be any major change to the average cost of a repair.
The main risk Ord Minnett envisages is that Suncorp will open the door for other insurers to benefit from similar cost-of-repair outcomes through AMA Group. Suncorp believes it is locking in a competitive advantage in motor repairs, having considered the sale on grounds that scale was needed for repairs and it was losing market share.
Nonetheless, Ord Minnett suspects that, if there is a competitive advantage, it would be difficult for Suncorp to maintain this with certainty, as other insurance providers can now use these shops through the AMA Group.
Suncorp has not indicated what will be done with the proceeds. Ord Minnett estimates it would allow the funding of around $400m in capital returns in the second half of FY20 and result in a net loss of about -$12m overall.
Macquarie now includes a $400m capital return in forecasts for the second half of FY20. The combined value of $440m for the two businesses equates to a profit on sale of $275-295m and a 25-year service agreement in Australia (12 years in New Zealand) adds to the attractiveness of the deal.
Citi anticipates there could be other areas of the Suncorp business with similar rationalisation prospects, such as wealth, and agrees the chances of a further capital return are high. The broker considers the sale of these motor businesses a sign that management intends to work capital harder.
Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, believes the deal is "excellent", assessing Suncorp is well-placed to deliver another special dividend at the interim result in February 2020 and/or a capital distribution at the full year result in August. The broker maintains a Buy rating and $14.80 target.
FNArena's database has three Buy ratings, two Hold and two Sell for Suncorp Group, with fewer than half the brokers updating for the divestment at this stage. The consensus target is $13.64 indicating 0.1% upside to the last share price. The dividend yield on FY20 and FY21 forecasts is 5.2% and 5.3% respectively.
For AMA Group the Capital SMART acquisition is expected to generate $17m in synergies by the end of FY21 while ACM Parts is expected to break even in FY20 and contribute $2m in operating earnings in FY21. This acquisition represents, a 10% share of the metropolitan drivable repair market.
AMA Group will fund the transaction by an equity raising consisting of an entitlement offer for $139m and a placement of $77m. A further $290m will be drawn down from the new senior debt facility.
The company will operate a total of 175 sites in Australia and four in New Zealand following the acquisition. Moelis assesses the acquisition strengthens AMA Group's position as the dominant player in Australia, enabling cost competitiveness.
The broker acknowledges headline acquisition metrics for AMA Group appear high but the delivery of synergies will help justify the upfront cost. Management expects $14m per annum in synergies from the optimisation of Capital SMART procurement, operations and overheads.
A further $3m per annum in synergies is available to the broader business from improved purchasing power. Moelis, also not one of the seven, increases FY20 estimates for operating earnings by 22% for AMA Group, maintaining a Buy rating with a $1.61 target.
See also, Suncorp To Focus On Margin Versus Growth on August 9 2019.
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