ARB Corp Decelerates

This story features ARB CORPORATION LIMITED. For more info SHARE ANALYSIS: ARB

A depreciating Australian dollar and soft vehicle sales have caused ARB Corp to decelerate, with first half net profit likely to be weaker.

-Turnaround in vehicle sales/change in offshore outlook required
-Flexibility from owning much of the manufacturing value chain
-4×4/SUVs sales an important impetus in the Australian aftermarket network
 

By Eva Brocklehurst

Vehicle component manufacturer/distributer ARB Corp ((ARB)) is experiencing extended downside risk to earnings although, as the chairman remarked at the AGM, "it's not all doom and gloom". First quarter sales revenue rose 5% but the depreciation of the Australian dollar against both the Thai baht and US dollar means will be difficult to offset by price increases or cost reductions.

Moreover, there have been further declines in new vehicle sales. Hence, first half net profit is likely to be below the same period last year. However, ARB Corp has pushed through three small price increases, the latest in early October, although Baillieu points out it will take time for these to take effect.

Ord Minnett acknowledges the company's track record of profit growth has been remarkable, averaging 12% over the past 15 years. The business is high-quality but there is a lack of material upside for the share price, in the broker's view, particularly given the downside risk to near-term earnings.

Credit Suisse also believes, for outperformance beyond this point, a meaningful turnaround in vehicle sales and/or a change in the outlook for the offshore businesses is required, although hastens to add the weakness is not structural.

New vehicle sales continue to trend down and declined -6.7% in the September quarter. Hence, Baillieu assesses the fact ARB Corp managed to sustain sales growth of 5% is favourable, and driven by a large growth in export markets.

Uncertain Economy

The company has highlighted uncertain economic conditions, which could affect sales and earnings. As with many automotive parts suppliers and retailers in Australia, price increases are required to offset cost inflation.

ARB Corp has flexibility, as it owns much of the manufacturing value chain, but achieving cost reductions from suppliers is hard and the depreciation in the Australian currency has not helped. The Australian dollar has depreciated against the Thai baht by around -30% over the past five years, Ord Minnett calculates.

Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, is not deterred by the prospect, upgrading to Overweight with an $18.75 target. The broker assesses sales growth is robust and the recent price increases should neutralise FX headwinds.

Structural Shift

Moreover, along with Baillieu, the broker considers long-term growth drivers remain compelling, including further structural shift to 4×4 and SUVs (sports utility vehicles). The company is also making significant investment in product development and distribution.

While passenger vehicle sales declined -7.5% over FY19, 4×4 and SUV sales continued to outperform, declining a more modest -1.6%. Given the company's exposure to this end of the market, Baillieu believes this category will be an important impetus for sales in the Australian aftermarket network.

Wilsons expects sales growth to accelerate in the second half, on the back of new OEM (original equipment manufacturer) contracts and the acquisition of Beaut Utes in New Zealand. The latter has around $15m in sales of 4×4 accessories in the NZ market and distributes ARB products.

The acquisition is expected to be positive for earnings per share in FY20. The company is also developing an increased focus on the emerging mid-sized truck market in the US. Credit Suisse highlights the fact ARB Corp does not often expand via M&A, albeit its track record in this area is very strong.

The stock has underperformed the Small Ordinaries index, while the shares have fallen -14% since the peak in mid-September, and Baillieu, also not one of the seven, upgrades to Buy with a target of $18.90.

Reasons for the upgrade including weakness in the share price, amid a long-term growth profile that remains intact. Strong returns continue on invested capital and the company has a strong financial position. Meanwhile, the FNArena database has four Hold ratings. The consensus target is $17.43, suggesting 2.3% upside to the last share price.

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