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Morningstar | Bapcor’s Weaker Same-Store-Sales are Temporary, Long-Term Outlook Remains Positive

Narrow-moat Bapcor reported an interim fiscal 2019 pro forma NPAT of AUD 43 million, a 7% increase on the previous corresponding period. Disappointingly, management guided to pro forma NPAT growth of 9% for the full year, shy of our prior 12% forecast, and at the bottom end of the previous 9% to 14% guided range. While the result and outlook were softer than we had expected, we believe the issues weighing on earnings are temporary in nature, and do not change our positive view on Bapcor. We’ve lowered our near-term estimates in line with the revised guidance, however, we maintain our AUD 7.00 per share fair value estimate. We believe the sell-off on the result release is an over-reaction to these cyclical headwinds and at the current price, the shares are attractively valued. The board declared a fully franked interim dividend of AUD 7.5 cents per share, up 7% on last year and tracking in line with our unchanged full-year expectations.

Performance in the core Burson Trade segment was slightly softer than expected, with same-store sales growth of around 2%. Despite falling short of our 4% forecast, we are unconcerned, and continue to view this as an attractive business. The softness reflects subdued consumer spending, which reflects the negative wealth effect of the weak property market, subdued wages growth, and political uncertainty, all of which are temporary. In our view 2% growth isn’t a bad outcome, considering new vehicle sales have fallen off a cliff while other consumer stocks have come under serious pressure. It demonstrates how resilient Bapcor’s core trade market is, and while consumers can opt to delay major vehicle maintenance, they cannot avoid it entirely. As such, we expect a modest catch up in maintenance expenditure in the coming years, before reverting to our long-term forecast of 4% per year, consistent with long-term historic averages. Demand is driven by size of the vehicle fleet, which should continue growing at a low-single-digit pace.

We were pleased to see Burson trade margins continue expanding, with management indicating they will not drop prices to stimulate same-store sales growth, which would undermine the firm’s intangible 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 products, and exercising greater bargaining power over suppliers.

The retail and service segment (which accounts for less than 20% of group earnings) delivered healthy revenue growth at 9%, however, EBITDA was flat on the prior year. The lower EBITDA margin (down by 100 basis points to 10.5%) was broadly as expected, as ongoing expansion of company-owned stores, and franchise conversions are margin-dilutive in the initial years. Same-store sales were also softer than expected, coming in at around 2% compared with our 4% forecast, consistent with the trade segment. Nevertheless, this is an acceptable outcome against the backdrop of a soft consumer environment, particularly as the retail segment is typically much more discretionary than the trade.

Despite slower new vehicle sales, the industry fundamentals remain healthy. Bapcor’s earnings are primarily linked to the size of the total vehicle fleet, which increased by around 2% in 2018 to approximately 20 million registered vehicles, with the average age remaining steady at around 11 years old. Additionally, we remain unconcerned by electric vehicles, which have negligible penetration of the vehicle fleet and represented less than 0.5% of new vehicle sales in 2018.

We are comfortable with the current state of the balance sheet, with net debt of around 2 times EBITDA. We forecast leverage to remain below 2 times for at least the next three years while the ongoing retail and trade network expansion continues, before starting to fall towards 1. Cash conversion was also a little soft during the period, falling to around 60% from almost 100% during the pcp. However, this is mainly reflective of higher inventory levels due to acquisitions, network expansion, and new product ranges. Management indicated cash conversion should improve in the second half, and we expect it will hover at closer to the 80% mark over the coming years.