In mid-July, we reviewed Bapcor (ASX:BAP) in order to assess the impact of COVID-19 restrictions on the Company’s businesses. With the shares having re-rated by over 10% since that time, we re-assess whether there is further upside.
Bapcor is Australasia’s leading provider of automotive aftermarket parts, accessories, automotive equipment and services. The Company’s operations are divided into four segments: Trade, Retail & Service, Specialist Wholesale and Bapcor NZ. The Trade segment is the largest contributor to earnings. It accounts for around 43% on an EBITDA basis.
Key Fundamental Drivers
Trade Segment Continues To Demonstrate Defensive Qualities
The defensiveness of the Trade business is a key cornerstone of the BAP investment case. In simple terms, car owners simply cannot delay service on their cars for very long. Accordingly, the recovery in Same-Store Sales growth (SSSg) in May/June, following a 10% decline in April was not unexpected.
These trends are heartening given that in Victoria, all of Metropolitan Melbourne, and the Mitchell Shire returned to Stage 3 lockdown for six weeks from 7 July. Stage 4 restrictions were introduced across metropolitan Melbourne from 2 August for six weeks. As such, the rate of SSSg in FY21 is expected to be tempered by the lockdown in Victoria, where there is a meaningful trade exposure. The Company has a total of 184 Burson Trade stores in Australia (of which 60 are located in Victoria) with a further 72 Burson Trade stores in NZ.
Prior to the latest lockdown in Victoria, we had expected SSSg in FY21 to be ~4.5% (i.e. in line with the trend of +4.5% SSSg reported for FY15-18), but we now expect it to moderate to ~3.5-4.0%.
Scope for Margin Expansion
BAP’s operating cost leverage is largely driven by its SSSg. Given the impact on sales during March/April, EBITDA margin for FY20 is expected to decline in comparison to FY19. However, EBITDA margin in FY21 is expected to recover, as the rate of private label penetration in Australia (currently ~24%) continues to expand towards the target of 35% across Trade in Australia and NZ. The extent of the recovery in EBITDA margin in FY21 is likely to be tempered by revised-down SSSg expectations for FY21 in light of the lockdown in Victoria.
A key factor likely to support EBITDA margin at a group level is that despite the impact from COVID-19, the Company, at the time of the equity raising in April 2020, was confident of maintaining: i) Price rises implemented in December/January 2020 in the Trade segment and ii) Gross profit margin. This implies that a rebound in demand means that there is likely to be less need for discounting and less risk of inventory build-up.
The recovery in EBITDA margin in FY20 is now less likely given that the Company has a meaningful retail exposure in Victoria, with 41 Autobarn stores (group total is currently 133 according to the Autobarn website), of which around half are located in Melbourne.
Supportive Industry Outlook Underpins Medium Term Outlook
While there are a number of factors supporting industry demand over the short term (i.e. low fuel prices, reluctance to use public transport, reluctance/restrictions around air travel and consumer preference for domestic holiday travel), we note the presence of a number of drivers that are likely to support the automotive parts industry growing well above its ~2-3% trend over the medium term. These include:
i. The average age of the Australian passenger vehicle is expected to increase given the continuing decline in new car sales (June 2020 represented the 26th consecutive monthly decline) and the commensurate strength in used car sales.
ii. Increasing penetration of Utes and SUVs that have materially higher service costs than smaller passenger cars.
Equity Raising Provides Further Balance Sheet Headroom
In April 2020, the Company announced that it would raise equity at $4.40 per share, via a $180m underwritten placement to institutional shareholders, as well as a non-underwritten Share Purchase Plan that raised $56m.
The additional equity raised from the institutional placement will lower the gearing level to a more comfortable level – 1.5x (on a net debt to annualised EBITDA basis) as at 30 June 2020. Gearing is likely to trend down further in FY21 given the historically high level of cash conversion (~100%).
With gearing now falling further below the covenant ratio of 3.0x, there is expanded headroom for the Company to undertake a number of internal initiatives, as well as to pursue further acquisitions. Acquisition opportunities are likely to come from the commercial truck automotive aftermarket parts market. This is in light of the current COVID-19 situation. There may be an opportunity for the Company to buy distressed parts assets from competitors.
We continue to view BAP’s fundamentals favourably and point to a number of factors in support of our view:
i. While there is an expected impact on EBITDA margin for each of the operating segments, EBITDA margin for each of the operating segments is expected to recover from FY21 onwards.
ii. The net profit growth profile (~15% for FY21 and FY22) remains attractive.
iii. The additional balance sheet flexibility following the recent equity raising increases the likelihood of further acquisitions, which have historically supported BAP’s earnings growth profile.
iv. Notwithstanding that the Asian store rollout strategy is in its infancy and has been impacted by the COVID-19 shutdown, the revenue potential ($100m from >80 locations) from the rollout in Asia remains.
The shares have now re-rated to a FY21 P/E of 21x, which is now above the average 1-year forward P/E multiple of ~20x over the last three years. It may be prudent for potential investors to wait for the release of full year results next Wednesday (19 August) in order to assess an appropriate entry point, assuming no major negative surprises.
After spending the last two months trading sideways, BAP looks as though it is ready to head higher again. There had been resistance near $6.15 but BAP managed to break above that several days ago. Although it has dipped back under that today, ideally we would like to see it hold around these levels. If we see any weakness, then support is likely to come in near $5.50.
Michael Gable is managing director of Fairmont Equities.
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