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Can ARB Stay The Course As Borders Reopen?

Australia | Mar 15 2022

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

The story below was originally published with a few inaccuracies, such as Credit Suisse downgrading instead of upgrading. These have now been corrected in the updated version.

ARB Corp reported a strong December first-half result in guidance, but as borders reopen, brokers are placing bets on the company’s ability to sustain the pace in the second half.

-ARB Corp walking FY22 tightrope
-Company swimming in opportunity
-Brokers have their say

By Sarah Mill

ARB Corp’s ((ARB)) first-half result met pre-released guidance in February, the company reporting extremely strong growth and gross margins, and sharply higher market penetration.

However, brokers remained split on the company’s outlook as borders re-open, interest rates start to rise and FX trends shift. The uncertainty was exacerbated by the company’s reticence to provide FY22 guidance.

ARB Corp is a 4WD accessories retailer that manufactures and distributes ARB-branded products to its 79-strong network of ARB branded retail stores in Australia and to third-party retailers in Australia and overseas (it exports to more than 80 countries and employs nearly 1,000 people).

ARB Corp Walking FY22 Tightrope

On the one side of the ARB argument are those who doubt the company will be able to cycle up into the second half as supply constraints, combined with increased capital-investment and covid-driven alterations in consumer demand, finally rein in the company’s margin growth.

On the other are those who believe the strong order book (10-12 weeks worth) and backlog of new cars provide strong margin visibility into the June half and are punting the company will seamlessly cycle out of covid into the post-covid operating environment.

They point to strong opportunities in the US as the company’s strategy there gains traction, and expect further increases in US car sales will further boost the company’s already strong aftermarket revenue – not to mention wildcards such as the Ford Licencing agreement which is already bearing fruit.

Then there are those in between.

Citi expects aftermarket sales to slow to 9% from 16% as sales constraints continue and discretionary activities switch to other leisure activities such as international travel.

But the broker says Citi’s auto survey of 2000 consumers shows the proportion of two or three car households are expected to rise in the mid-west and south-west over two years. Citi says these two regions account for 68% of the market.

Citi holds a Buy rating but cuts the target price to $48.15 from $57 and expects second-half margin to fall as higher freight and shipping costs bite.

Pretty much without exception, all brokers note the company has several opportunities to expand the business and that while capital expenditure in increased inventories may prove a drag (the company reported weaker cash-flow in the half as a result) it will position the company well to leverage any increase in demand. Analysts are generally positive on the long-term horizon.

For example, ARB has already doubled the size of its Thai manufacturing facility and has made strategic US acquisitions with potential dealership activity available.

Brokers also appreciate the track record of management and consider ARB to be a high-quality business.

Brokers have their say

Post the February results release, Credit Suisse upgraded to Neutral from Underperform with an unchanged $40.60 target price, taking a conservative stance heading into the riskier June half.

The broker argued the share price was trading at a premium (albeit still at its historical average) to valuation and suggested any negative development could trigger a downgrade. It has to be noted, ARB's share price has fallen by circa -18% since.

Morgan Stanley meanwhile has moved to Overweight after the recent share price sell-off thinking it may be time to buy the dip.

The broker pegs a target price of $56, noting the price-earnings multiple is still below the five-year average and the company is a high quality, high growth proposition swimming in opportunity.

The broker believes the Thai expansion points to stronger manufacturing scale, which it believes points to greater operating leverage, given ARB has been capacity constrained – hampering top line growth.

Morgan Stanley acknowledges reopening concerns but is confident the company’s structural growth in exports is sustainable, the company demonstrating strong growth in market penetration. 

JP Morgan is less optimistic focusing on the company’s weaker cash flow, lack of specific guidance, and a general indication that it expected weaker OEM sales.

The broker is Underweight on valuation reasons and holds a target price of $36.

JP Morgan fears the share price reflects more potential than reality and may be inflated by stimulus and the reallocation of international travel discretionary business. Again, this view was expressed before the recent share price de-rating.

Ord Minnett holds a Buy recommendation and $52.20 target price, appreciating the 15.6% jump in Australian aftermarket sales, which was struck on just a 1% growth in new vehicles; and the 39.9% jump in export sales which included those from the US Truckman acquisition. 

This broker expects continued demand for 4WD accessories in both the SUV and 4WD markets; continued expansion of the ARB store network and stronger penetration in overseas markets.

Macquarie, like Ord Minnett, believes the company is shifting up a gear.  The company reported a clean result with strong performances from all segments and appreciates the expanded manufacturing facility.

Macquarie's only concern is a potential fall in customer demand as borders reopen. Macquarie retains an Outperform rating and holds a $48 target price.

Wilsons believes ARB Corp will defy supply constraints and margins will remain elevated near term and crank up a gear.

The average target price in the FNArena database is $48.99. It's calculation does not include JP Morgan or Wilsons. Yesterday, ARB shares closed at $37.80, almost -30% below consensus target.

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