Sales Gridlock Hampers GUD Holdings

This story features G.U.D. HOLDINGS LIMITED. For more info SHARE ANALYSIS: GUD

As lockdown grips Australia's largest city, automotive component supplier GUD Holdings has put off providing any guidance for FY22, while costs remain elevated

-GUD Holdings relying on price to offset cost inflation
-Automotive market should recover quickly once mobility returns to normal
-Has the company now weathered the trough in margins?
 

By Eva Brocklehurst

Once again, the resurgence of lockdowns across Australia has clouded the outlook for the automotive industry supply chain, and thus GUD Holdings ((GUD)), which has deferred earnings guidance until its AGM in October as a result.

Credit Suisse is not surprised no specific guidance was provided at the FY21 result, given the uncertainties relating to the pandemic. Although the lockdowns continue to warrant caution, the broker does not believe its 5.2% organic automotive revenue growth forecast for FY22 is aggressive.

Cost inflation is not insignificant yet Credit Suisse believes it is mostly transient, although acknowledges freight costs may take time to normalise. The competitive position of the company's brands also means it is arguably better placed to deal with the headwinds and take market share.

Citi asserts GUD Holdings is relying on price to offset cost inflation, having increased selling prices by 3% on average and contemplating another round of price rises in the second half.

The broker considers the shares fairly priced as the company is likely to be challenged to generate more than single-digit growth over the medium term without acquisitions or a significant export strategy, forecasting slower organic automotive growth in FY22 of 5%, driven by price rises.

GUD Holdings has indicated it remains on the lookout for acquisitions and can still complete such despite the lockdowns. The company remains focused on the 4WD sector. Citi's analysis suggests an acquisition with an enterprise value of $120-150m can be obtained without leverage increasing above 2x.

July Slowdown

Macquarie notes FY22 started well but then the lockdowns caused disruption, pointing to July automotive sales being broadly in line year on year and then volumes tapering later in the month as Sydney's lockdown intensified.

Some volume growth is expected organically in FY22 and cost headwinds should stabilise in the second half. Citi highlights, in some cases, NSW is experiencing daily sales down -12-15% following the implementation of mobility restrictions.

The company is hoping sales bounce back sharply when restrictions are eased, which occurred after the Victorian lockdown in 2020, yet the broker is concerned there is less stimulus in the economy this time around.

Macquarie asserts the automotive trade aftermarket is defensive and should recover quickly as mobility returns to normal. The average age of vehicles on the road is increasing, expected to be 10.9 years by 2025 from 10.4 years in 2020, and this is positive as the "sweet spot" for aftermarket revenue is vehicles that are more than five years old.

FY21 earnings (EBIT) of $101.2m ($101.9m from automotive and a -$4.8m decline from water) was at the top end of guidance and up 26%, and the dividend pay-out ratio recovered to more than 80%. Yet while the result rose meaningfully most of the growth was in acquired businesses, Macquarie points out.

Re-seller inventory building had largely played out by August 2020 and demand was robust throughout the rest of FY21. The water business experienced manufacturing challenges because of the pandemic as well as compliance costs.

The result highlighted margin pressure in the automotive business in the second half, while Ord Minnett was underwhelmed by the contribution from the recently-acquired G4CVA business, as indeed was Wilsons. The latter expects the stock will trade at a discount to the market because of the sustained erosion in margins of the core automotive business.

Margin

Despite largely favourable trading conditions in the 4WD segment, automotive margins declined -200 basis points in FY21. Given the decline in margins in the second half, Ord Minnett remains concerned about any operating de-leverage if the demand profile shifts.

Yet Credit Suisse envisages a trough has been found for margins, suspecting used car volumes and utilisation will emerge from the pandemic at a structurally higher level.

On the other hand, Wilsons highlights margin decline has been sustained over the past five or more years and reflects not just cyclical factors such as cost inflation but structural factors such as portfolio mix and higher customer rebates.

This decline impacts on the broker's valuation assessment, regardless of the robust growth rate in earnings. Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, has a Market Weight rating and $11.85 target.

FX Impact

The business is highly reliant on imports priced in US dollars and there was some expectation there would be benefits from currency hedging in FY22. Yet management has indicated this benefit has probably dissipated, absorbed by supplier cost inflation and business reinvestment.

The database has two Buy ratings and three Hold. The consensus target is $12.96, suggesting 10.8% upside to the last share price. The dividend yield on FY22 and FY23 forecasts is 5.0% and 5.1%, respectively.

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