EUR 850.00 For Business Accounts Only

Morningstar | Regulatory Reform Hits Automotive Earnings During Fiscal 2018, Although Outlook Remains Healthy

Narrow-moat-rated Automotive Holdings reported a soft fiscal 2018 result with underlying net profit after tax of AUD 75 million, down 14% on the prior year but in line with our expectations. The weakness reflected the ongoing margin pressure from regulatory changes to finance and insurance commissions and relatively soft consumer demand. The board declared a final dividend of AUD 6.8 cents per share, which took the full-year total to AUD 16.3 per share, down almost 20% on the prior year, although within the company’s target payout ratio of between 65% and 75% of underlying net profit. We maintain our AUD 3.30 per share fair value estimate and still see upside at the current share price.

The near-term outlook for automotive dealerships is likely to remain challenging, given the tight consumer lending environment, the flow-on effect of a softening housing market, and ongoing pressure on margins from insurance and finance commission reform. These pressures drove EBITDA margin down 30 basis points to 3%. We expect the company to mitigate some of this margin pressure through cost-cutting initiatives, and eventually through pricing increases, while the timing of the margin recovery will largely depend on how quickly the competition adjusts its pricing. Our earnings forecasts are unchanged, and we remain confident the firm can recoup around 50 basis points over the next five years and sustain a group EBITDA margin of around 3.5%, broadly in line with the average during the past five years.

The company has a solid track record of undertaking earnings-accretive acquisitions, extracting synergies, and benefiting from operating leverage, which helped it grow automotive margins by around 10 basis points per year on average, during the seven years leading up to fiscal 2016, which is when the regulatory pressure kicked in. We are, however, pleased with the top-line numbers and expect the company to continue gaining share in the highly fragmented automotive retailing market. We still expect the top line to grow at a mid-single-digit pace on average, reflecting low-single-digit growth in annual new vehicle sales, modest pricing increases, and incremental market share gains.

The refrigerated logistics segment showed modest signs of improvement, with revenue and EBITDA growing by 1% and 8%, respectively, despite the second-half earnings being disrupted by its unsuccessful divestment attempt. While we were disappointed that the sale of this division fell through, we believe the company will continue trying to offload the division, given its long track record of underperformance. The company is implementing new systems, including transport management, warehouse management, and IT, all of which should help the margin recovery continue, albeit at a modest pace. We assume the segment’s EBITDA margin can approve by around 1% cumulatively during the next five years to 7%, which is still below prior levels, given the segment’s lack of competitive advantage.