Eagers Automotive: Proving up structurally higher margins

About the author:

Josephine (Jo) Little
Author name:
By Josephine (Jo) Little
Job title:
Former Senior Analyst
Date posted:
29 July 2021, 10:30 AM
Sectors Covered:
Consumer Discretionary (Retail)

  • Eagers Automotive (ASX:APE) will deliver A$218.6m Net Profit before Tax (NPBT) in 1H21 (11% above MorgansF) vs A$40m pcp.
  • Importantly, APE’s quarterly PBT trajectory continues to accelerate (A$56m/A$112m/A$98m/A$120.6m 3Q20/4Q20/1Q21/2Q21), taking into account some seasonality.
  • Below we discuss why we see an increased likelihood of structurally higher margins for APE. EPS forecasts lift by 10% in FY21 and 20% in FY22/23.
  • PT lifts to (login to view); Add rating maintained.

Event

Eagers Automotive (ASX:APE) provided 1H21 underlying Net Profit before Tax (NPBT) guidance of A$218.6m (vs heavily COVID-19 impacted A$40.3m in pcp). Statutory NPBT is expected to be A$264.7m.

Analysis

2Q performance: Given APE achieved A$98m of underlying NPBT in the 1Q, guidance implies 2Q NPBT of A$120.6m (45/55 1Q/2Q skew). APE’s recent quarterly NPBT trajectory as follows – 3Q20 A$56m (incl. cA$12.5m VIC impact); 4Q20 A$112m; 1Q21 A$98m; 2Q21 A$120.6m

FY21 run-rate: 1H guidance implies a FY underlying NPBT run-rate of cA$437.2m, with OEM bonuses typically larger in December than any other month, lending further upside.

What about FY22? Prior to today’s update, consensus had forecast FY21 NPBT of A$370m falling to cA$300m in FY22, assuming utopic margins are unsustainable. APE’s previous peak NPBT margin (prior to the demand downturn and over-stocking by OEMs) was c3.5% (implying cA$320m on current revenue). Stripping out c25bp as our estimate of the eventual earnings impact from F&I regulatory change, but adding back A$100m of structural cost-out, equates to cA$400m of underlying NPBT. This is, of course, before factoring in any future upside from two of APE’s key growth targets – EA123 and higher F&I penetration. It also doesn’t fully account for APE’s property buybacks which are realising lease cost savings (net of funding costs).

The supply/demand landscape: we think recent earnings strength is just as much about strength of demand as it is supply constraints. With chip issues continuing, global OEMs having 2025 targets around EVs (why ramp up combustion engine manufacturing too much) and all parts of the channel more profitable under a more just-in-time environment, we see a reversion to previous metal margins as unlikely.

Reminder of EA123: APE currently sells around 65k used cars pa via is traditional franchise auto channel vs 100k new cars (0.6:1) and an additional 12-15k within EA. APE is targeting to sell around 50k units in the med-term which, based on A$500-1,000 NPBT/car, would equate to A$25-50m NPBT business/upside. This would take the used:new ratio >1. We are yet to fully factor this upside into our forecasts, but note it could be meaningful growth driver, in future years.

Reminder of F&I opportunity: our analysis suggests that every 1% move in APE’s F&I penetration rate increased PBT by cA$2.5m. Assuming penetration can move from c40% to 60% (still below US/UK avg of 80%), would create a A$50m PBT opportunity.

Forecast changes

We lift our FY21 underlying NPBT forecast to A$410m (+10.5% from A$371m prev.). This implies a c4.6% margin. While this forecast is well below APE’s current run-rate, we take a more conservative approach with 5 months of the FY year to go and NSW lockdowns extending.

Our FY22 underlying NPBT forecast lifts to A$370m (+20% from A$309m prev.) and implies a 4% margin. We see risk to the upside with our forecasts.

Investment view and valuation

We think the market is underestimating APE’s ability to sustain a structurally higher margin in future years, underpinned by an entrenched cost-out and other drivers clearly within the company’s control (EA, F&I, M&A, property buybacks). Somewhat outside APE’s control, but looking more likely, is the potential for OEMs to act more rationally (relative to demand) moving forward.

APE is trading on c14x/15.6x our FY21/FY22 forecasts, boasts a strong balance sheet with minimal net debt and c4.5% yield. Add rating maintained; PT (login to view).

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