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Morningstar | ARB Share Price Comes Back to Earth Following Substantial De-Rating

After falling by 35% during the past few months, shares in narrow-moat rated ARB are only slightly overvalued relative to our AUD 15.00 per share fair value estimate. The share price de-rating follows the declining housing market and weakening consumer spending.

Despite some near-term softness, we believe the company can sustain mid-single-digit revenue growth in Australia for the next five years, supported by ongoing expansion into new product categories, market share gains, and modest price increases. We forecast Australian operating margins to remain steady at around 20%, in line with historic averages, as price increases and strict cost control help to offset rising electricity and gas costs, rising steel prices, and the weaker Australian dollar. The company’s brand power underpins its ability to justify a price premium over competitors and continue passing through rising input costs.

Whilst new vehicle sales have been extremely disappointing in recent times, falling by between 5% and 10% each month, the impact on ARB has been relatively minor. The company’s main target categories are medium and large sport utility vehicles (SUVs) and four-wheel-drive utilities, and these categories have continued to grow, despite deterioration in the new vehicle sales market. Four-wheel drive utilities and SUVs (excluding compact SUVs) now represent around 44% of new vehicles sold in Australia, compared with 35% in fiscal 2014. In any case, we expect this dip in new vehicles, which is reflective of a softening housing market, to be temporary and over the long term should resume growing at 1%-2% per year. The firm will add another four Australian stores during fiscal 2019, up from the current 63 stores, and Australian aftermarket will remain the largest category and the main valuation driver for the foreseeable future.

Given the maturity of the Australian market, exports remain the fastest-growing category (14% per year on average over the past five years), although the share of revenue remains relatively small at just over one quarter. The potential for global trade wars and consequential uncertainty is weighing on consumer demand, although we continue to expect double-digit export growth for at least the next five years. The company’s penetration of USA, Europe, and Middle East is negligible, and has room to grow. Management has demonstrated its commitment to growing exports by establishing and growing offshore sales and servicing capabilities while increasing warehousing and distribution capacity.