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Morningstar | No Surprises in GUD’s Fiscal 2018 Result; FVE Lifted by 5% to AUD 11 Per Share

We increase our fair value estimate for no-moat GUD by 5% to AUD 11 per share after rolling our model forward to reflect the firm’s fiscal 2018 results. The company’s underlying EPS (from continuing operations) rose by 20% on the prior year to AUD 0.64, marginally below our AUD 0.66 forecast. The core automotive division (90% of group EBITDA) was the main driver of the strong earnings growth, continuing to deliver above-market growth rates, in line with our expectations. The board declared a final dividend of AUD 0.28 per share, up 13%, taking the full year to around AUD 0.52 per share (fully franked), in line with our expectations.

Management did not provide any explicit earnings guidance, although we expect the core automotive business to continue delivering strong growth, with revenue likely to increase at a high-single-digit pace on average during the next five years. This will consist of around 3% annual price increases, in line with recent trends, while the Australian vehicle population should continue growing at around 2% per year. In addition, the company should continue benefiting from new product releases, entry into adjacent markets, and the new Narva catalogue. During fiscal 2018, automotive revenue grew by 16%, 9% of which was organic, with the remainder composed of a partial contribution from recent acquisitions. GUD will continue pursuing incremental bolt-on acquisitions, adding further revenue upside, and fiscal 2019 should benefit from full-year contributions from the recently acquired AA Gaskets and DBA.

Automotive EBITDA margins dipped slightly to around 29%, compared with 30% last year, although this is mainly attributable to the slightly margin-dilutive earnings contribution from recent acquisitions. Typically, the company has been able to extract synergies from acquisitions, and we project automotive margins returning to 30% within the next two to three years. Given the company’s lack of competitive advantage and a fairly concentrated customer base, we don’t envisage a scenario where the company can sustain margins higher than this level without attracting additional competition or pushback from key customers Repco and Burson.

The stock remains overvalued relative to our revised fair value estimate. As mentioned in prior notes, one of our key concerns is the company’s exposure to internal combustion engine, which currently represent almost 50% of group sales and an even higher proportion of earnings, in our view. While this is not an imminent threat, we still believe that over the long term, electric vehicles will be phased out, affecting the firm's core market. While management acknowledges this threat, the recent acquisitions of AA Gaskets and Disk Brakes will not help insulate the company.

Reported net profit was exceptionally strong at AUD 102 million, compared with AUD 7 million loss last year. This included around AUD 47 million in nonrecurring and discontinued items, primarily related to the sale of Oates, which recorded an AUD 52 million profit on sale.

Strong cash conversion and the profitable sale of Oates helped strengthen the balance sheet considerably, with net debt falling to AUD 92 million from AUD 161 million. Net debt now represents about 1.1 times underlying EBITDA, and on our estimates should hover below 1 for the foreseeable future. This gives us comfort the firm can sustain a dividend payout ratio of at least 80% of underlying EPS for at least the next five years, while leaving firepower to continue undertaking incremental acquisitions without putting the balance sheet under any pressure.

Managing director and CEO Jonathan Ling has resigned from the company. We believe Ling has done an exceptional job of transforming the company, divesting numerous noncore and underperforming businesses, including Sunbeam, Lock Focus, Dexion, and Oates. He departs on Sept. 30 and will be replaced with Graeme Whickman. Whickman is the former president and CEO of Ford Australia and New Zealand, a position he has held since 2015, and his career with Ford exceeded 20 years, including global senior executive roles.