The market liked the financial results of G.U.D. Holdings (ASX:GUD) in August for the 12 months to 30 June 2023 (FY23). However, the share price failed to hold on to any gains. Volatility in equity markets played their part. Investors have also been concerned about the impact on GUD from a potential slowdown in automotive demand. In turn, this prompted us to investigate whether the weakness presented a better re-entry opportunity. We assess whether current levels are still attractive.
About G.U.D. Holdings
The core operations of GUD comprises only the Automotive segment, which provides a wide range of parts for both the automotive after-market and new vehicles. The Company recently exited from Davey Water Products. This business was involved in the manufacturing and sale of water hardware and treatment products. In FY23, it only comprised ~3% of overall EBITDA.
GUD’s Automotive segment comprises: i) ‘Core’ Automotive, which includes Ryco, IMG, AA Gaskets, DBA, Wesfil, BWI and Griffiths Equipment and ii) ‘Acquired’ Automotive, which includes G4CVA, ACS and Vision X.
The Company’s portfolio of automotive aftermarket companies includes long-standing brands like Ryco, Wesfil and Goss. In recent years, GUD has grown this portfolio with the acquisition of strong brands such as Narva, Projecta, AA Gaskets, Injectronics, and Disk Brakes Australia (DBA).
The acquisition of Auto Pacific Group (APG) in FY22 has created the 2nd largest 4WD accessories and trailering business in Australia and NZ. APG is reported as a separate segment and is expected to account for around 1/3rd of overall EBITDA in FY24.
Key Fundamental Drivers
Are Market Concerns About a Slowdown in Automotive Demand Valid?
GUD issued a trading update to the ASX at the Company’s AGM on 26 October, for the 1st quarter of FY24 (1Q24). The Company reported solid sales growth for 1Q24 (compared to the prior corresponding period) across all key auto businesses. While not quantified, “solid sales growth” implies around mid-single-digit % and is reflective of the resilient aftermarket demand for wear and repair parts.
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There are market concerns that there could be downside risk to a mid-single-digit % sales growth rate. This is based on a weaker-than-expected trading update from ASX-listed peer Bapcor (ASX: BAP) in mid-October. Bapcor’s trading update referred to highlight challenges from a softer automotive trade end market.
However, it is worth noting that:
i. Bapcor is closer to the end consumer, so any consumer slowdown (service deferrals and trade down activity) would likely be seen at Bapcor earlier than GUD.
ii. Bapcor is in the midst of a major business transformation program and distribution consolidation programs, so it appears that Bapcor is underperforming the sector, especially given that trading updates from other peers (i.e. GPC and Super Retail Group), in addition to GUD’s commentary, also point to buoyant trading conditions in automotive aftermarket.
iii. As flagged at the FY23 results release in August, the Company is undertaking incremental capital investment across the ‘Core’ Automotive business in FY24. The capital investment aims to target a number of quality brands owned by GUD with offshore growth potential. In context, the level of capital investment is modest, which minimises risk.
iv. The APG segment provides a potential offset to lower sales growth in the ‘Core’ Automotive business in FY24. This is because APG is well leveraged to improving supply of new vehicles. In context, while the ‘Core’ Automotive business is leveraged to the size of the “car parc” and average vehicle age, the APG business is leveraged to new vehicles sales
Operating Leverage Remains Despite Short-Term Margin Pressure
Despite stronger-than-expected revenue growth in FY23, there was margin pressure. This was predominantly driven by lower production throughput in the G4CVA manufacturing business. G4CVA continues to be constrained by vehicle constraints and severe labour shortages.
EBITA margin for the Automotive segment declined by 90 basis points, with EBITA margin for the ‘Core’ and ‘Acquired’ business declining by 30 basis points and 250 basis points, respectively. However, EBITA margin for the ‘Acquired’ business recovered strongly in 2H23 (+410 basis points to 17.3%). This was due to the reconfiguration of existing ECB manufacturing resources improved sales mix. The Company expects the EBITA margin for the ‘Acquired’ business to remain between 15-20% over the longer term.
Margin forecasts for ‘Core’ Automotive in FY24 have been revised downwards. This is driven by continued inflationary pressures, incremental capital investment to grow offshore operations and a slower trajectory of improvement in G4CVA. The latter remains the laggard in GUD’s portfolio, but has the potential to leverage GUD’s broader 4WD capabilities in time and deliver meaningful earnings improvement.
Notwithstanding the downgrade to margin in FY24, we still expect margin accretion (i.e. operating leverage) out to FY26.
Gearing Expected to Reduce Further
Gearing (on a net debt to adjusted EBITDA basis) as at 30 June 2023 was 2.0x, which declined from 2.4x as at 30 June 2022.
Proceeds from the sale of Davey Water Products will be used to pay down debt and is expected to result in gearing (on a pro-forma basis) declining to ~1.8x. This level is at the midpoint of GUD’s medium-term target of 1.6-1.9x. Given that cash conversion is expected to return to the typical 85-90% range in FY24, there is potential for a further reduction in gearing levels. In context, cash conversion in FY23 improved 35% to 113%, as supply chains normalised and net working capital unwound.
Since our report, GUD shares have re-rated to a 1-year forward P/E multiple of ~13x. We still consider this multiple to be attractive in the context of an EPS growth profile of ~8% over FY23-26 on a CAGR basis.
Key catalysts for the shares include:
i. A declining gearing profile, which brings further Merger & Acquisition into play. In contest, GUD has a strong track record.
ii. The potential for upgrades to EPS estimates over the medium term from improved vehicle supply in APG and capital investment to grow offshore operations.
GUD has trended well since the start of the year. It has corrected back a couple of times (blue lines), and is once again moving higher. There is nothing wrong with the way GUD is trading here and we should see it head to new highs for the year.
Michael Gable is managing director of Fairmont Equities.
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