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Morningstar | Bapcor Our Preferred Exposure in the Automotive Sector, Attractively Priced at Current Levels. See Updated Analyst Note from 20 Jun 2019

Narrow-moat-rated Bapcor remains one of our preferred names in the automotive space, currently trading at almost 20% below our AUD 7.00 per share fair value estimate. We have not changed our earnings projections and the company remains on track to achieving 9% underlying net profit growth in fiscal 2019. We forecast earnings per share to grow at just over 10% on average over the next five years.

The core trade market (which directly contributes around 60% of group earnings, and as much as 80% including the specialist wholesale division) is still showing some softness, but nothing to be alarmed about. We attribute this to the general softer macro conditions, and relatively subdued consumer confidence, neither of which are structural headwinds. We maintain our long-term expectation of 4% growth in like-for-like sales, driven by approximately 1%-2% annual growth in the size of the vehicle fleet, and modest pricing increase. In contrast to other automotive stocks, Bapcor’s earnings are supported by maintenance of the fleet. While consumers can opt to delay major vehicle maintenance expenditure, avoiding it entirely would have catastrophic consequences, a scenario we believe is unlikely to play out. We believe if the macro environment and new vehicle sales remain weak for a prolonged period, maintenance expenditure could increase as consumers opt to prolong the life of their vehicle as opposed to trading up. The firm’s expansion strategy is unchanged, and it remains on track to growing the number of Burson trade stores to 230 within the next five years, compared with the current 179. As the main consolidator in the trade space, the firm is likely to continue gaining market share, and we expect it to reach almost 40% within the next five years, compared with a third currently.

Despite the near-term softness, we continue to expect Bapcor to expand its trade margins. Pleasingly, the company maintained margins during the first half of fiscal 2019, and the company held firm on pricing without losing any market share, which attests to the brand strength. We forecast trade EBITDA margins to increase by around 200 basis points from current levels to 16% by fiscal 2021, reflecting a growing proportion of own brand sales, the benefits from optimisation projects, and exercising greater bargaining power over suppliers.

Whilst still very early days, Bapcor Thailand is starting to show promise. The firm now operates four Burson trade stores and plans to open another in the next month. The Thai market is a significant opportunity with a vehicle fleet of circa 16 million, compared with Australia’s 19 million, and the fleet is growing at around 5% per year, almost double the pace of Australia. At present, the earnings contribution from Asia is negligible and the company has a lot to learn about the local market. However, if the company’s domestic success is anything to go by, then Asia could become a meaningful contributor over the next decade.

Being slightly more discretionary in nature, the retail business will be slightly more challenging. Same-store sales growth will likely be somewhere in the low single digits in the near term. However, this is also a cyclical challenge, and over the long term we are positive on the outlook for the Autobarn chain which should sustain same-store sales growth of closer to 4%. The firm is going through the process of buying back underperforming franchise stores. While at face value this is dilutive to profit margins and returns on invested capital, the corporate stores are outperforming the franchise stores, and the dollar value contributed should increase. The Autobarn store rollout pipeline is deep, with a five-year target of 200 stores compared with the current 131. This is factored into our assumptions and should support a 13% revenue CAGR over the next five years. We estimate retail EBITDA margin to decline by around 250 basis points from fiscal 2018 levels to 10% within the next three years and remain at approximately this level thereafter.