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Eagers Automotive: Demand Trumps Supply Issues

Australia | May 19 2022

An increasing order book for Eagers Automotive keeps brokers Buy-rated despite vehicle supply issues and rising interest rates.

-Eagers Automotive guides to a lower first half profit
-Elevated new car orders despite a supply shortage
-The effect of rising interest rates
-Short and longer-term margins

By Mark Woodruff

Brokers have generally set lower target prices for car retail group Eagers Automotive ((APE)) following weaker than expected first half guidance, driven largely by supply pressures.

Nonetheless, the company’s order book has grown a further 25% in the year-to-date. Forward orders are written at full gross profit margins, which prolongs the current supportive conditions, notes broker Moelis.

The market is under-appreciating the value of the order bank, according to Macquarie, which underwrites a significant portion of earnings for the next 12 months.

While guidance for first half profit of between $183-$189m is lower compared to the previous corresponding period, management predicts a stronger than normal second half performance once supply improves. Morgan Stanley estimates an achievable $211m will be required in the second half to hit the consensus estimate.

The semi-conductor chip shortage issues from 2021 have persisted and have been further exacerbated by the Ukraine conflict and China’s ongoing covid lockdowns. While Neutral-rated Credit Suisse factors-in to its earnings forecasts the potential for supply chain improvements, general uncertainty around this outcome dictates a -10% valuation discount be applied to its target price, which falls to $12.40 from $14.60.

Of course, the current interest rate environment could weigh, though Ord Minnett believes negative sentiment from rising rates has been captured by the current share price and retains its Buy rating.

Valuation

Prior analysis by UBS suggested a strong correlation between new car purchases and property values, and investors are cautioned around reduced consumer demand should interest rate rises suppress house prices.

Despite this warning, the broker feels the current valuation for Eagers is undemanding and points to other positives including ongoing rationalisation of the property portfolio, increased earnings from easyauto123 (used cars) and additional acquisition opportunities.

Wilsons agrees on valuation, which is one reason for its upgrade its to an Overweight rating from Market-weight. Other reasons include a quality management team looking to optimise the business footprint, grow the exposure to finance and increase used car market share.

The broker, not one of the seven brokers updated daily in the FNArena database, raises its target price to $13.77 from $13.75.

Margin analysis

The growing order bank provides Jarden, also not one of the seven, with ongoing confidence in stronger margins for longer. Given ongoing delivery delays and no evidence of demand subsiding, the broker upgrades its gross profit margin for FY23.

The analyst believes the strong order book and supply chain headwinds have prevented the new vehicle market from running with the housing market, which should lessen the negative wealth effect should house prices decline due to rising interest rates. The broker lowers its target price to $14.04 from $15.21.

Credit Suisse agrees that very strong earnings margins achieved in FY21 can be maintained for FY22 and FY23. However, once supply becomes equal to or greater than demand, margin compression is expected by the beginning of FY24 and is forecast to continue into FY25.

Meanwhile, Bell Potter continues to forecast a decline in underlying operating profit in 2023 and 2024 as supply constraints ease, which also results in lower forecasts for margins. At the same time, the analyst points to upside risk to at least 2023 earnings forecasts, as margins should remain strong for a period until the backlog of orders is mostly cleared.

The broker retains its Buy rating and reduces its target price to $15.50 from $17.25.  Along with the Buy-rated Moelis (which also reduces its target to $16.96 from $17.06), Bell Potter is not one of the seven brokers updated daily in the FNArena database.

Within the database there are six broker ratings with five Buy (or equivalent) ratings and one Hold and a consensus target price of $16.60, which suggests 44.3% upside to the last share price.

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