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Morningstar | Softer Domestic Market Weighs on ARB’s Sales, Although Long-Term Earnings Outlook Remains Positive. See Updated Analyst Note from 20 Feb 2019

Narrow-moat rated ARB reported interim fiscal 2019 revenue of AUD 218 million and profit before tax of AUD 38 million, growth of 6% and 5%, respectively. Sales to original equipment manufacturers (OEMS) grew the fastest at almost 22%, reflecting new contracts commenced during the year, although this was offset by softness in the core Australian market. Management highlighted a continuation of sales growth during the first six weeks of the second half, although cautioned that unstable economic conditions remain in some of ARB’s key markets. At the current pace the firm is tracking marginally below our expectations. Accordingly, we’ve trimmed our fiscal 2019 EPS estimate by around 4% to AUD 43 cents. However, our long-term projections and AUD 15.00 per share fair value estimate are unchanged. After falling by almost 30% during the past six months, shares in ARB are only marginally overvalued to our valuation. The board declared an interim dividend of AUD 18.5 cents per share, a 6% increase on last year, fully franked.

The Australian region (over 80% of group sales) grew revenue by a modest 4%, marginally below our 6% forecast. The domestic softness is a reflection on the soft domestic consumer environment and slower domestic new vehicle sales, both of which we attribute to the negative wealth effect from declining housing prices. However, the impact on ARB has been limited, as the company’s primary target categories are medium and large sport utility vehicles (SUVs) and four-wheel-drive utilities, both of which have outperformed the broader new vehicle sales market. In any case, we believe the softness is cyclical, and our long-term projections are broadly unchanged. We continue to expect the firm to generate mid-single-digit sales growth in the core Australian market, underpinned by ongoing expansion into new product categories, a resumption of 1%-2% per year growth in new vehicle sales, incremental market share gains, and inflationary price increases.

We forecast Australian operating margins to remain at around 20% for the foreseeable future, broadly in line with historic averages. Price increases and strict cost control will help offset higher energy and steel prices, along with the weaker Australian dollar that 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.

Exports grew at a moderate 7% during the period, albeit slightly below our expectation, and disappointing compared with the 14% per year growth generated during the past five years, although the share of group revenue remains relatively small. We expect exports to continue growing at a faster pace than the domestic market as: (1) the Australian market is already heavily saturated, (2) ARB already dominates the local market by a considerable margin with limited scope for market share gains; and (3) the growth is off a low base, as offshore markets represent only 20% of group sales compared with the 65% generated in the Australian aftermarket. Management has demonstrated its commitment to growing exports by establishing and growing offshore sales and servicing capabilities while increasing warehousing and distribution capacity. The company’s penetration of the USA, Europe, and Middle East is negligible, with considerable room to grow, and we project offshore revenue growth in the low- to mid-teens percentage range for the foreseeable future.