Treasure Chest: Scale Beckons Peter Warren

This story features PETER WARREN AUTOMOTIVE HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: PWR

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Peter Warren Automotive is navigating NSW lockdowns cautiously, yet the re-opening recovery along with acquisition potential may indicate an opportunity

-Major upgrade to guidance could be forthcoming
-Is the forward order book decreasing?
-Acquisitions could scale up the business substantially

By Eva Brocklehurst

The fortunes of Peter Warren Automotive ((PWR)) have been underpinned by strong demand even as supply constraints created by the pandemic impede deliveries of new motor vehicles.

Morgan Stanley has now become more bullish on the stock and assesses, even if its bear case estimates for sustainable pre-tax profit of $50m prove correct, the market is factoring in an undemanding $60m pre-tax profit in FY23.

The main catalyst for the stock is the re-opening of NSW, from where 50% of its base is located, and a return to more normal car purchasing markets. The company appears to assume lockdowns in NSW extend beyond the current government setting for the end of September and this made guidance provided at the FY21 results appear very conservative.

Yet even with the potential for re-opening NSW in late October, Morgan Stanley notes the factors supporting the outlook are many. Housing wealth effects are intact and there will be no competition from international travel for some time while the preference for personal over public transport continues.

No update to the prospectus forecast for first half FY22 pre-tax profit of $28m was provided at the results, as company remains mindful about the impact of lockdowns in NSW, and to a lesser extent Queensland, combined with supply chain constraints.

At the time of the results in August, Peter Warren Automotive was exposed to lockdowns in NSW and Queensland and Morgans suspects prospectus forecasts for the first half were simply reiterated, as would represent a -43% contraction versus the second half profit of $48.8m in FY21.

Moelis accepts management has been very conservative in its forecasts and the roll-out of the vaccine in NSW leading into the December/January holiday period should mean vehicle demand recovers strongly, and may mean FY22 guidance is upgraded.

Yet the broker has a niggling suspicion the order book could be decreasing. There will also be a couple of months lead time before new orders for cars can be delivered and this may create an earnings hole.

Moelis estimates Peter Warren has 2-3 months worth of sales in its order book that should be delivered during the first quarter. Still, the order intake in Sydney is likely to remain subdued during the lockdown and deliveries are unlikely to be replenished with new orders. Moreover, constrained supply will mean deliveries will not happen immediately once restrictions are eased.

Yet Morgans disagrees, assessing the forward order book is strong and lockdowns are simply delaying earnings rather than causing cancellations. Jarden considers the risks are about the cyclical nature of the industry, which means Peter Warren Automotive is exposed to changes in consumer sentiment as well as macro factors that constrain discretionary expenditure.

Margins

The main positive in FY21 was elevated gross profit margins, with Moelis noting operating cash flow was $85m. Gross profit margins improved to 18.3%. The Queensland business has also bounced back strongly after lockdowns in July, demand for cars remains robust and supplies constrained, so Moelis expects this margin will continue in FY22.

Service income is also affected by the lockdowns albeit partially offset by cost reductions. Around -40% of the business is locked down, Moelis calculates, and service income in affected areas is down -20%. Should this continue for the rest of the first half the broker estimates this would produce a -$2.2m net impact of pre-tax profit as the company can reduce staffing costs to mitigate some lost income.

Moelis has upgraded estimates for FY22-23 by 16-20% to reflect the elevated margins, albeit slowly reducing, as well as the recent acquisitions, and applies a 20% probability weighting to an assumption that Peter Warren Automotive can internalise the family-owned Toyota business.

Acquisitions

The company has recently acquired several assets which are not included in Morgan Stanley's forecasts as there was little detail disclosed, albeit they should still provide some tailwind. The four dealerships include three in NSW and one on the Gold Coast and were acquired in June/July. 

While pointing out little value is being attributed to organic growth, the broker makes comparisons, in terms of the acquisition outlook, with the trajectory of Eagers Automotive ((APE)) which gained substantial scale after the merger with Automotive Holdings.

Hence, the broker takes a long view on the growth trajectory, although acknowledges market concerns about the current shape of demand in the wake of the pandemic. Moelis agrees there is a long trajectory for growth available as the industry consolidates and a enlarged dealer group can benefit from scale.

The broker also notes ongoing discussions around further acquisitions and there is $42.9m in net cash on the balance sheet. Morgans suspects the company is intent on a larger "prize", such as acquisitions with $400-600m in turnover, and agrees sizeable acquisitions have the potential to change the profile of the stock considerably.

Jarden has a target of $4.32 with a Buy rating and Morgans an Add rating with a $4.09 target. Moelis has a $4.79 target and Buy rating while Morgan Stanley retains an Overweight rating and $4.60 target.

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