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Morningstar | Unfavourable Mix Shift and Weakness in Davey Weigh on GUD’s Margins in 1H

No-moat-rated GUD’s net profit after tax, or NPAT, from continuing operations rose by 14% in the first half of fiscal 2019 to AUD 29 million. This was driven by strong growth in the core automotive segment, although this mainly reflected the first full six-month contribution from recently acquired Disk Brakes Australia and AA Gaskets. The board declared a fully franked interim dividend of AUD 25 cents per share, a 4% increase on the previous corresponding period, at a 74% payout ratio.

At the current pace, the company is tracking marginally behind our previous fiscal 2019 full-year normalised NPAT projection which we’ve now trimmed by 3% to AUD 60 million, reflecting lower margins and softness in Davey. Management didn’t provide any explicit earnings guidance, although it expects further improvement in the second half reflecting the Narva Catalogue release in the fourth quarter, full-year contribution from other automotive products, and improvement in Davey reflecting sales initiatives. Our long-term forecasts are unchanged, as is our AUD 11.00 per share fair value estimate. Having fallen by around 30% in the past six months, shares in GUD now trade in line with our fair value estimate.

We’ve lifted our fiscal 2019 automotive revenue forecasts slightly to reflect the 18% segment growth, however, only 5% of this was organic, the remaining 13% from contributions from the acquired businesses. We expect the company to continue making bolt-on acquisitions in the auto space and deliver around 10% annual EPS growth on average over the next five years. We remain concerned with the significant exposure to internal combustion vehicles (around 42% of revenue), which will become a smaller part of the vehicle fleet over the long term. While at present, the penetration of electric vehicles is negligible, it is growing, and we believe the most recent acquisitions do little to alleviate this concern.

Within auto, the slightly stronger revenue was more than offset by softer margins, which reflects a less favourable mix shift with contributions from the newly acquired (but lower-margin) businesses. However, we are unconcerned by this, and we believe the company can maintain its track record of extracting synergies from acquired automotive businesses and lift the segment EBITDA margin back up towards 29% within the next three years, clawing back the two percentage points forgone during the first half of fiscal 2019.

Davey continues to struggle amidst the East Coast drought, which is particularly impacting the rural sector and weighing on demand, especially through the summer season. This drove flat revenue, slightly below our low-single-digit growth forecast. Additionally, margins were slightly down although they should improve in the second half given the additional sales initiatives. In any case, the segment only represents around 10% of group earnings, hence has limited impact on our valuation.