AMA Group: Rising Costs, High Debt Raise Alarm

This story features AMA GROUP LIMITED. For more info SHARE ANALYSIS: AMA

Some brokers have become less comfortable with the high debt on AMA Group's balance sheet. Others see an attractive valuation, and consolidation opportunity.

-Investors scared off by AMA Group's large 1H loss, no interim dividend
-Some broker say FY20 earnings guidance looks optimistic
-High debt raises chance of debt covenant breach

By Nicki Bourlioufas

Investors sold down smash repair company AMA Group's ((AMA)) shares in February following the release of weak half-year results which included reporting a statutory loss of -$12.3m. While management restated its FY20 earnings guidance, some brokers are doubtful its forecasts will be achieved.

AMA Group, the market leader in vehicle panel repairs and automotive parts and accessories in Australia, reported its earnings before interest, taxes, depreciation, and amortisation (EBITDA) dropped -22% on the previous first half despite contributions from acquisitions driving 34% revenue growth.

Reduced repair volumes due to prolonged dry weather and lower insurance claims frequency dragged on the financial results. The company owns and operates several businesses and brands and is the largest accident repair group in Australia. Stagnant pricing of repairs and rising costs, as well as acquisition costs, weighed on earnings.

A decrease in new car sales also weighed on its earnings. Adding to the losses was the impact from the adoption of new accounting standard AASB 16 Leases.

Despite the headwinds, AMA restated its FY20 guidance for underlying EBITDA of $73m to $77m, but brokers respond this looks "optimistic". A sharp fall in AMA's price confirms the market's scepticism. “Given the stock closed the day at $0.59/share (down -24%) investors appear dubious of guidance,” said Canaccord Genuity in a research note. Canaccord has reduced its target price to $1.30 from $1.40.

According to Wilsons, the company's FY20 guidance looks “very optimistic” and a favourable outcome on pricing discussions with key insurers to mitigate cost inflation in the second half is critical to the earnings outlook.  The broker has a $0.64 target price on AMA.

While AMA’s valuation is seen as attractive, the risks are described as “elevated” on both earnings and the balance sheet. The outcome of discussions with insurers in the second half will dictate the EBITDA margin run-rate into FY 2021, says Wilsons, which assumes the Panel EBITDA margin increases to 7.9% in H2 and 9.0% in FY21 and beyond.

Moelis has reduced its EBITDA forecast by -9% to $64m (it was $70m) and also dropped by -8% its FY21 estimate to $101m, below company guidance, largely due to more conservative assumptions around timing of recovery in Panels and Parts & Accessories, and the Capital SMART integration/synergy implementation. Moelis has downgraded AMA to a Hold with a target price of just $0.66.

Another disappointment for investors was that no interim dividend was declared given 1H trading underperformance and “robust” acquisition pipeline. AMA, however, expects to pay a full year dividend in August 2020.

Drowning in debt

High debt is another problem for the company. Net debt for the 1H period was $238.8m, which Canaccord estimates represents net debt to equity of 58%. The broker forecasts FY20 net debt of $245m. Based on guidance around FY21 EBITDA of $110m, that would represent a leverage ratio of circa 2.2x on net debt of $238.8m.

Wilsons notes a need for balance sheet repair given a debt covenant breach is possible. Wilsons forecasts a leverage ratio at 2.9x in FY 2021 and says a breach will arise if that ratio rises above 3.25x. Under this scenario, an equity raising of up to $100m would likely be required. Wilsons has retained a Market Weight rating.

There is, however, some good news for AMA. Outside the first half problems of dry weather and rising repair costs, the second half period will benefit from a full six-month contribution from the Capital SMART integration, which is expected to deliver EBITDA of $17m.

AMA says the Capital SMART integration is well progressed and management is confident of delivering in excess of $17m of synergies for FY21.

Bell Potter remains upbeat and sees the valuation as attractive. Bell Potter did decreased its price target by -29% to $1.00, but as this remains at a significant premium to the share price, the rating remains Buy.

UBS too remains optimistic. UBS sees a consolidation opportunity within the Australian panel repair market and with AMA shares trading on a FY21 PE of 7.7x (pre-AASB), “we think a substantial re-rating opportunity exists if AMA can successfully deliver on guidance and renegotiate pricing to cover the higher cost of parts.”

UBS maintains its Buy recommendation, having reduced its price target to $1.20 from $1.30, though it does still sees earnings risk depending on how negotiations go with the major insurers. 

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