Australia | May 24 2021
While it’s difficult to predict how long current strong conditions will prevail for Eagers Automotive, brokers see ongoing earnings momentum arising from multiple sources.
-Car shortages to persist in the medium term
-Potential uplift from EasyAuto123 strategy
-Strong M&A rhetoric by management at Eagers Automotive
By Mark Woodruff
The year-long share price ascent of Eagers Automotive ((APE)) continues unabated. At the time of writing, the shares in Australia’s largest car dealership group had appreciated $10 over that period to reach $15.45, a rise of 182%. The company is experiencing unusually strong market conditions where demand continues to materially outstrip supply.
In last week's AGM trading update, management revealed $127m of underlying profit (NPBT) for the first four months of FY21. This has set brokers off on another round of upgrades to forecast earnings.
After taking into account that January to April is seasonally weaker for the group and for the industry, extrapolation of the run-rate suggests full year profit of $400m or more is achievable, explains Morgans. This assumes current conditions continue, so to be conservative, the broker incorporates $371m into FY21 estimates.
The company’s forward order book continues to grow as demand continues to outstrip supply by roughly 25%. Significant promotional activity normally occurs in May and June and along with EOFY tax incentives Moelis expects a stronger second quarter compared to the first.
The Daimler Truck sale and associated property completed in April and the $108m of proceeds are being cycled back into the core auto business. This makes sense to Morgan Stanley, with the synergies and opportunities on offer. The broker maintains an Overweight rating for the stock with a target price of $18.
Margins
Despite no signs as yet of conditions moderating, Moelis adopts a conservative stance by assuming gross profit margins moderate in the second half.
The company managed to extract -$100m in cost savings during covid and the broker expects further margin upside from two additional ways to drive efficiency. Firstly there is the prospect of property rationalisation around strategic hubs. Also, investment in technology will automate some back-end processes in the service department.
Both consensus and Morgans currently forecast that FY22 profit will fall materially when compared to FY21. This is on the assumption that margins normalise as supply constraints ease. Should the strategies mentioned in the next section play out, there could be upside to these forecasts. In addition, there is the potential for accretive M&A.
Other Tailwinds
Aside from prevailing industry conditions (shortage of supply), Morgans believes earnings momentum may arise from a number of sources. These include the above-mentioned structural removal of -$100m worth of operating costs. Additionally, the strategies of attaining finance and insurance (F&I) penetration and EasyAuto123 profitability will likely provide an extra push.
The shortage in new car supply has also pushed up the price of used cars, benefiting the company’s used car business EasyAuto123. Chief Executive Keith Thornton noted “2020 saw EasyAuto123 move to being consistently profitable with growth continuing into 2021.”
In a note preceding the trading update, UBS also highlighted the strongest April new car sales data on record and ongoing supply issues driven by global semiconductor chip shortages. As a result, the broker expected a continuation of buoyant conditions from the first half of FY21 to the end of calendar 2021.
Even without the chip troubles, Eagers Automotive management observed back in February there had likely been a structural shift in total global supply. This was being caused by the permanent reduction of excess capacity and the closure of uneconomic factories.
The company then anticipated car shortages to persist in the medium term, with an around -20-25% reduction in global car units supply following covid-related cost-reduction measures. Supply was also being impacted by disrupted auto parts chains and OEM’s deciding where to send capacity.
Outlook
With demand continuing to materially outstrip supply, combined with the extension of the instant asset tax write-off, Moelis sees no signs of demand subsiding. After the result, the analyst upgrades FY21 EPS forecasts by 8% and retains a Buy rating with a $17.82 target price.
The broker estimates demand continues to outstrip supply by approximately 25% and so the company’s forward order book continues to grow. Significant promotional activity normally occurs in May and June and along with EOFY tax incentives a strong second quarter is expected.
Over the medium term, Morgans still thinks the group looks well placed with further operational improvements, capital recycling and M&A expected to assist profitability. The broker lifts FY21-23 EPS forecasts by 9%, 2.1% and 2%, respectively, and lifts the target price to $17.39 from $16.86.
Mergers and Acquisitions
With regard to M&A, management noted the group was “extremely well capitalised” ($507m of available liquidity and $436m of property) and is actively reviewing multiple acquisition opportunities. Sydney and Melbourne were highlighted as being underweight markets for the company, and will therefore likely be target regions.
This is the first time since pre-covid that Morgans heard strong rhetoric in relation to M&A. This is considered an important point given the company’s successful track record in this area. Additionally, there is potential for acquisitions to assist in bridging any potential gap, when industry margins ultimately partly normalise, as supply constraints ease.
Summary
Moelis, not one of the seven stockbrokers monitored daily on the FNArena database, has a Buy rating and $17.82 target. The database has five Buy (and equivalent) ratings and one Hold (Credit Suisse). The consensus target is $16.42, suggesting 10.10% upside to the last share price.
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