Good conditions: Automotive Holdings Group revs up for 2015

Chief Investment Officer and founder of Aitken Investment Management
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As I tone down our multi-year bullish stance on the major Australian banks (underweight) and Telstra (neutral), that alone represent 35% of the benchmark ASX200, I continue to scour the industrial market for what I would describe as “earnings growth at a reasonable price” meets “dividend growth at a reasonable price”. As I keep writing, growthless yield will perform like a utility from here. If you want capital growth, you must now focus on earnings growth & dividend growth.

I am trying to find structural top down growth themes and then identify the best earnings and dividend leverage to that theme at the best risk adjusted valuation.

Yesterday I attended a management presentation by the $1.2 billion market cap Automotive Holdings Group (AHE). In my view this stock ticks all the boxes I am looking for that should ‘drive’ FY15 relative and absolute outperformance.

Australia has a driving culture and Australians love a new car. When you then overlay strong population growth and household formation, the best car affordability readings since the 1970s and readily available finance, you can understand why new car sales have done this over the last decade.

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Heavy Federal and State Government investment in new road projects will ensure the private car remains the transport “weapon of choice” for the Australian population. Similarly, the overall fuel efficiency of cars continues to improve at the same time as insurance costs fall due to competition. I think the macro overlay for new car sales growth in Australia remains structurally strong.

It’s worth remembering that the private sector represents 52.4% of the new vehicle sales market. That private sector grew +3.9% in FY14 to 587,903 units, with manufacturer incentives to new car buyers supporting demand growth.

This is where macro meets micro: AHE generated +9.7% revenue growth from that +3.9% market wide private sector growth, EBITDA growth of +13.6%, EBITDA margins up to 3.4% and EBIT +14.1%. PBT grew +17%. Yes, some was acquired growth, but the vast majority was organic growth.

AHE doesn’t just sell new cars. New vehicle sales are complemented by multiple revenue streams of strong used vehicle sales, finance & insurance, service and parts. AHE is Australia’s largest automotive retailer by sales volume and workforce.

What attracts me is AHE’s diversity by brand and state. AHE has passenger vehicle and bus and truck dealership operations in QLD, NSW, VIC, and WA. AHE also has passenger vehicle dealerships in NZ. Passenger brands include Alfa Romeo, Bentley, Chrysler, Citroen, Dodge, Fiat, Ford, FPV, Holden, HSV, Hyundai, Jeep, KIA, Mazda, Mitsubishi, Nissan, Peugeot, Porsche, Subaru, Suzuki, Toyota, and Volkswagen. Truck and commercial vehicle brands include Freightliner, Fuso, Higer, Hino, Iveco, JAC, LDV, Mercedes-Benz, Rosa and Volkswagen Commercial.

“Automotive” represents 82% of AHE group revenue and 74% of AHE group EBITDA.

The other sectorial contributors to group revenue and ebitda, namely refrigerated logistics and other logistics, are where the analyst community seems to get their knickers in a knot. But to my way of thinking the “tail” is wagging the overall valuation “dog” and that is opening up the contrarian opportunity in AHE.

No doubt the contribution from refrigerated logistics was disappointing. Even we downgraded our EPS growth forecasts for FY15 and F16 by -4% and -3% respectively. Interestingly, the stock didn’t react to those downgrades and perhaps the -3% relative underperformance of the stock in the three months into the result was already discounting a somewhat messy refrigerated logistics result. It’s worth pointing out the “disappointment” came from existing businesses, not the acquired Scott’s or JAT, which are travelling well.

At the macro level, I can only see demand for fully integrated temperature controlled transport and cold storage solutions rising. Despite the weather in Sydney over the last few days, we remain one of the hottest continents on earth with vast transport distances from producer to market. Overlay strong population growth with demand for fresh produce and this refrigerated sector will see structural long-term growth. AHE describe most of the issues in refrigerated as “one off”, and if that proves right, which I think it will, then EBITDA margins should head towards 10%. On that presumption, the AHE group P/E will advance to a mixture of retailer and transport stock.

What I find interesting is on FY15 estimates AHE is cheaper (11.6x) than all discretionary retailers and it’s major transport sector peers (TOL 13.6x, MYR 13.6x, HVN 16x, JBH 13.3x, FLT). That is despite having a very strong track record of delivering growth in revenue, margins, EPS and DPS.

Operating^1 – excludes costs and fees in relation to integration and aquisition-related actvities, asset divestments, impairment and sale of properties.

Similarly, you can’t point to the balance sheet as the reason for the P/E discount to its peers. With interest cover of 4.8x, undrawn facilities and cash of $100m, and net debt to total assets of 15%, the balance sheet is stronger than the vast majority of its listed peers.

The other aspect that attracts me to AHE is corporate appeal. It is worth noting that the listed AP Eagers (APE) recently increased their AHE holdings to 19.87%. There is no doubt AHE is a strategic play, but it’s currently not priced as one and that tends to explain the creeping above. Our numbers are below.

On FY15 and FY16 estimates AHE is cheap, offering combined year EPSG of +31% for a combined P/E of 22.2x and combined fully franked yield of 12.9%x. ROE is also solid at 15%.

On a 2yr PEG ratio of .72x, averaged dividend yield of 6.45%ff, I think AHE is a cheap EPS and DPS growth stock.

There is no doubt in my mind that a 2 P/E point discount to listed discretionary retailers and ground transport stocks is a mispricing. I believe that mispricing will close and AHE will see a re-rating to 13.6x FY15 EPS once the market becomes more confident in that EPS being delivered. 13.6x FY15 EPS of 32.8c = a price target of $4.46.

The added bonus is the stock is still cum the 12.5cff FY14 final dividend, which enhances the prospective “13 month yield” to 9.36%ff.

If, like me, you are looking to drive in a different lane from a portfolio perspective, then AHE as Australia’s biggest automotive retailer (and largest/youngest refrigerated transport fleet) has all the attributes that should generate total return outperformance. That includes being an M&A target itself.

While it’s only a mid-cap, I am going to call AHE a high conviction buy.

Go Australia, Charlie

100% of Charlie Aitken’s fees for writing for the Switzer Super Report are donated to The Sydney Children’s Hospital Foundation.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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