By Leo Sek – Clime Asset Management
Super Cheap Auto Group (ASX:SUL) retails automotive spare parts, car care appliances as well as power tools, outdoor products and bicycles in Australia and New Zealand.
SUL operates three businesses:
– Supercheap Auto, representing 66% of EBIT
– BCF, representing 34% of EBIT; and
– Goldcross Cycles which is loss producing
Supercheap Auto is the largest retailer of aftermarket automotive parts and accessories in Australia and New Zealand. Its product range covers batteries, car care, exterior accessories, hand and power tools, in car navigation systems, in car stereo, oils, filters and additives, garden equipment, seat covers and interior accessories, spare parts, paint and panel.
The business’ strategy is to be the best value retailer of car maintenance, car enhancement and handyman products. Supercheap Auto operates multi format stores with a small number of superstores (approximately 1,200 square metres with extended product range) and small format stores (approximately 400 square metres with focused product range).
Supercheap Auto currently operates 265 stores with a target of 300 stores. It has a program to refurbish 40 stores each year. In addition, the business aims to grow sales through expanding their offering into travel, touring and garage storage and providing value added services such as fitment services.
We believe Supercheap Auto is a maturing business as evidenced by the declining rate of new store openings (from 39 stores in FY04 to 6 stores in FY09). Further at this point we believe the Australian auto aftermarket will grow at low single digits in the medium term.
BCF was established in 2005 through the purchase of the CampMart business consisting of 4 Brisbane stores. BCF retails boating, camping and fishing products through 64 stores in Queensland, ACT, New South Wales, Victoria, Northern Territory and Western Australia.
BCF has a target to have 80 stores and this was raised from 70 stores in FY09. BCF opened 4 stores in the first half of FY10. Assuming the run rate continues, it will reach its target within the next eighteen months. Therefore, the opportunity for growth from new store openings is limited.
The business hopes to achieve sales growth by entering into new categories such as water sports and kayaking, trailer camping, ski, hiking and apparel. BCF aims to lift gross margins by stgeloping own brand products, replicating the strategy successfully used in Supercheap Auto.
BCF’s product range is tailored to suit regional areas e.g. regional variation in the popularity of brands of fishing equipment. This has had the effect of lowering inventory levels and increasing gross margins.
Goldcross Cycles retails bicycles, accessories, parts and apparel. The business was acquired in June 2008 with 11 stores in Melbourne. Now, the business operates 18 stores in Melbourne, Brisbane, Gold Coast and Sunshine Coast.
The business plans to open 50 stores over the next 5 years and aims to achieve 5% p.a. like for like sales growth and 8% EBIT margin.
At this point Goldcross is losing money and is affecting the total returns reported by SUL.
Following the GFC it is likely that discretionary consumer spending will dip in Australia and impact sales growth across the group. However, a weaker economy may be positive for sales of auto maintenance products as consumers retain and maintain existing cars rather than buy new cars. Similarly a change in consumer behavior to holiday more in Australia would be positive for the full range of SUL products.
A stronger Australian dollar reduces the cost of imported goods and cost of goods sold as SUL sources products from overseas e.g. China. This will positively impact gross margins for SUL unless competitors begin to discount.
At this point Goldcross Cycles faces competition from online businesses who can usually offer lower prices to consumers. Major bicycle brands may not want to supply Goldcross Cycles, for example, Giant withdrew supply from Goldcross in 2008 after it was acquired by SUL. Given the large price tag associated with new bike frames, we believe the business is highly susceptible to changes in general economic conditions. Also its working capital management is different from the other two divisions.
Goldcross Cycles is in the stgelopment stage and its success depends on stocking the right product range, including own branded products; pricing; store formats and sites; marketing and supply chain stgelopment. It also needs to grow to a critical size which we suspect is about twice its current level.
Performance Valuation: Super Cheap Auto Group Limited (ASX:SUL)
Both the profit and the normalised return on equity (“NROE”) have grown over the last five years. We regard this as a highly commendable characteristic. Further, forecast FY10 NROE is a healthy 29%. A dividend payout ratio of circa 50% has allowed shareholders to receive a growing income plus provided adequate retained earnings for SUL to fund its growth.
The quality of reported profit is high with operating cash flow exceeding profit after tax from the period FY06 to first half FY10.
It seems the only dent in SUL’s performance is Goldcross Cycles. The business has been loss making since acquisition and management expects an EBIT loss in the second half of FY10 of $2-3m. This compares with BCF which turned a profit in the year after it was acquired, delivering EBIT margin of 9%, higher than the 7% of the established Supercheap Auto business.
If Goldcross Cycles was discontinued, approximately $24m of equity can be freed up to fund organic growth or returned to shareholders. However, at this stage management appears committed to the Goldcross rollout and we wish them well but suspect it will be a difficult task.
Gearing is moderate with net debt per equity of 53%.
We have adopted a required return of 14.1% which is appropriate given the moderate level of gearing offset by the maturity of the industry. The growth in turnover towards $1 billion means the company is amid sized retailer.
The market currently requires a 30% rate profitability (“APF”) to justify the current price. We prefer to be more conservative given the rising interest rates environment and the losses from Goldcross and so have adopted 28%. SUL should be able to achieve this comfortably, with a rising $A, the current run rate of new store openings and like for like sales growth.
SUL is trading around fair value at current levels and investors should look for market dips to acquire this well performed company.
Clime Asset Management and StockVal are part of Clime Investment Management (ASX:CIW).
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