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Morningstar | Shares in GUD are Slightly Undervalued After Declining for 12 Months

After falling by around 30% during the past year, shares in no-moat-rated GUD are now slightly undervalued relative to our unchanged AUD 11.00 per share fair value estimate. Despite a challenging 12 months for new vehicle sales, GUD’s near- to medium-term earnings outlook is healthy. This is because the firm’s sales are more closely tied to the size of the vehicle fleet, which doesn’t fluctuate greatly from year to year. Group sales (from continuing operations) should comfortably grow at a high-single-digit pace for the foreseeable future, underpinned by a steady 1%-2% annual growth in the vehicle fleet, while the average vehicle age is likely to remain at around 10 years. The remaining revenue growth will be derived from low-single-digit pricing increases, expansion into new product categories, and small bolt-on acquisitions.

Margins have softened during the past two years, although we aren’t concerned, as this reflects less favourable mix shift with contributions from the recently acquired businesses. We believe the company can extract synergies from acquired automotive businesses and return the segment EBITDA margin back towards 29% within the next three years, clawing back the two percentage points forgone during the first half of fiscal 2019. However, we believe the bargaining power lies with GUD’s powerful customers Repco and Burson, which collectively control around two thirds of the auto parts retailing trade segment, which will keep margins constrained at our forecast levels.

The main downside risk would be a rapid acceleration in electric vehicle, or EV, sales, however, this is at least a decade away giving the firm time to diversify its exposure. At present, just under half of GUD's automotive sales are purely linked to internal combustion engines, which will eventually be phased out. Among these are the Ryco fuel and oil filters, which are two of firm's core products. While our base-case scenario is for EV penetration of the fleet to remain immaterial for the next decade, beyond this period there is a material risk as many of the core products will become redundant. This could put the firm under pressure to continue making acquisitions, and the risk of overpaying or for strategic mis-steps is high.