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Morningstar | Exports Will Continue to Drive Healthy Earnings Growth for ARB but Shares Remain Expensive

After rallying since the start of calendar 2019, shares in narrow-moat-rated ARB trade at an approximate 20% premium to our unchanged AUD 15.00 per share fair value estimate. While growth has moderated in fiscal 2019 to-date, our long-term expectations are unchanged, and we forecast 8% EPS growth on average over the next five years. We think the market is overly optimistic about the growth potential in the local market, which we view as highly mature and saturated.

While the long-term outlook for the domestic market is relatively positive and should grow by mid- to high-single digits on average, we expect growth to moderate in the near-term. This reflects the softening macro environment, declining property prices and weaker consumer confidence spending. These pressures are weighing on discretionary spending and new vehicle sales, which will reduce demand for ARB’s products. New vehicle sales have declined by high-single digits during the past 12 months, whereas SUV and four-wheel drive sales (ARB’s primary exposure) have held up relatively well in comparison. SUVs (excluding compacts which are typically not accessorised by ARB) fell by 2% in the nine months to March 2019, whereas 4WD utilities grew by a modest 2.5% during the same period. This subsegment now accounts for approximately 46% of new vehicle sales, a 10-percentage point increase in the past five years and will most likely continue to outpace the broader vehicle sales market.

Australian EBIT margins should remain steady at around 20% for the foreseeable future, which is broadly in line with historic averages. The firm will continue to increase prices and exercise strict cost control, to offset higher energy and steel prices, along with the weaker Australian dollar which impacts Thai baht denominated operating costs. The company’s brand power underpins its ability to justify a price premium over competitors and continue passing through rising input costs.

In contrast to the domestic market, exports are performing strongly. We forecast export growth in the mid-teen percentage range on average over the next five years, with the U.S., Europe, Asia, and the Middle East doing most of the heavy lifting. By fiscal 2023, we believe exports will represent almost 40% of group sales compared with almost 30% currently. The growth outlook is supported by increasing penetration of new regions, along with additional investment into infrastructure, marketing and support for key export markets. The new global warehouse in Thailand will substantially increase warehousing and production capacity, while increasing the efficiency of the global distribution network. The offshore business should also be buoyed by the lower Australian dollar which is likely to remain under pressure for the foreseeable future.

Product development and innovation are crucial drivers of the company’s brand strength and narrow economic moat. We forecast R&D to continue to grow in Australian dollar terms, but steady at around 2% of group sales for the foreseeable future. The company remains at the forefront of product innovation and a couple of recent noteworthy developments include the accommodation of parking assist sensors, radar and cameras which enable adaptive cruise control, emergency and lane departure.