Income Report / Income Report; Should we follow Nick Politis & buy back into AP Eagers (APE, AHG, MTO, ASG)

By Market Matters 07 November 18

Income Report; Should we follow Nick Politis & buy back into AP Eagers (APE, AHG, MTO, ASG)

Market Matters Income Report 7th November 2018

The ASX is trading marginally lower with most sectors in the red, offset largely by support from Commonwealth Bank (CBA) after a better than feared quarterly trading update. As was the case with the other banks over the past week or so, there wasn’t anything really dramatic in the update and as a consequence, the stock is grinding higher. Cash profit for the quarter came in at $2.5b putting it on track for a full year number of $10.2b. Currently the market consensus sits at $9.93b so potentially some incremental upgrades to come, although it is only Q1.

Commonwealth Bank (CBA) Chart

The US midterms are under way and we are starting to get an indication of how the cards are falling. Firstly, for the US House to get a majority they need 218 seats (from 435 seat chamber). Essentially, Democrats need to take 23 seats from Trumps Republicans, and the polls are showing they should do this, however we all know how wrong polls can be!

For the week, the MM Income portfolio added 0.48% against a backdrop of the ASX which added  +1.21%. For the financial year to date, the portfolio is down -0.78%  versus its benchmark of RBA cash rate +4% which sits at +1.93% while the ASX 200 accumulation (including dividends) is down by -3.88%. Since inception (5th July 2017) the portfolio has added 5.24% versus its benchmark of +7.36%. The biggest drag on the portfolio in recent times has been our call to increase exposure to retailers through Nick Scali (NCK) and Super Retail (SUL), both of which have been under significant pressure.

Should we follow Nick Politis & buy back into AP Eagers (APE)

Is it just me or does there seem to be a lot of new cars getting around the streets, mostly European SUVs while car show rooms are more akin to retail Apple Stores than traditional car yards?  

Mosman Audi (owned by Autosports Group - ASG)

We held  AP Eagers (APE) in the MM Income Portfolio when it was launched last year, but sold out soon after as it became clear the stock simply lacked a catalyst to move higher. Recently we’ve seen Nick Politis, the Chairman of the Sydney Roosters and major shareholder in APE increase his stake – he now holds more than 36% of the business. This prompts the question, should MM be following Mr Politis and buy back in after a reasonable drop in share price and furthermore, are there opportunities in the ‘car yard’ sector more broadly for yield conscious investors?

Backdrop

It’s not just me, the number of new SUV’s driving around the suburbs is now pretty astonishing with nearly 50% of all new cars sold in October being SUVs. However, while SUV sales are going well as a proportion of the entire pie, the growth in the pie has been slowing considerably. New vehicle sales were down in Australia for the 7th consecutive month in October, declining by around 5% with most of the drop being felt in New South Wales and Victoria, coincidentally, the states that are experiencing the largest drop in home prices from the peak.

As interest rates fell and ultimately bottomed in 2016, it was almost cheaper to trade in an old vehicle on a higher finance package and buy a new vehicle on a cheaper rate, especially when the rise in your home value over the coming months would more than offset the added liability of new car finance.

Now however, home prices have come back from the peak and are trending lower while interest rates globally are going up. Unemployment is a factor and right now unemployment is low and will go lower according the RBA, but we’re yet to see any meaningful increase in wages. Ultimately house prices and wage growth flow into a consumers appetite to spend and right now, these factors are working against the car yards, and the retailers more generally for that matter making them cheap on historical metrics.

Here’s a look at the ‘car yard’ stocks in our coverage; They’re clearly cheap & pay great yield.

1 AP Eagers (APE) $7.04

On a relative basis, APE is the most expensive with the lowest yield, although it is the largest by a reasonable margin with a market capitalisation of $1.35b. They have a broad spectrum of car dealerships mainly in eastern states covering pretty much all the major brands. Ultimately, APE will follow the trends in car sales nationally and it’s hard to see this trend changing any time soon. Share prices follow earnings over time with a high degree of accuracy, or the cynic would say that earnings expectations follow share prices and that’s probably true in terms of APE.

APE Earnings Expectations (red line) share price (white line)

While the stock is cheap and the major shareholding ‘topping up’ is a good sign, we simply couldn’t be long APE given the trend in earnings. Technically, APE looks destined for lower levels.

MM is neutral / negative APE

AP Eagers (APE) Chart

2 Automotive Holdings Group (AHG) $1.89

AHG is a holding company for a large group of Automotive dealers across Australia and New Zealand. They floated back in 2005 with a market capitalisation of $140m and today they are worth ~$640m.  Recent share price performance has been incredibly weak with the stock falling from a 2018 high of $3.87 to close yesterday at $1.88. The business is cheap trading on a forward P/E of 9.2x while yielding 8.52%, however as is the case with APE, the earnings trends are poor. In 2016 when the stock was trading in the $4  range, they were earning more than 30cps while today they’re expected to earn around 20cps. The drop in earnings and associated PE re-rate (down) justifies the slide in share price.

AHG Earnings Expectations (red line) share price (white line)

Again, while the stock is cheap we simply couldn’t be long AHG given the trend in earnings. Technically, $1.60 support is the obvious target.

MM is neutral  AHG however a test of $1.60 support could look interesting

Automotive Holdings (AHG) Chart

3 Autosports Group (ASG) $1.285

Autosports Group are behind many of the higher end dealerships around Sydney, Melbourne & Brisbane including 6 of the impressive Audi centres, one I go past each morning in Mosman. In all, they have 37 retail operations  having started operations in 2006. They are reasonably new to the ASX having listed in 2016 at $2.40, and it’s been a downhill slide ever since – shares trading at around half that price today putting it on a market capitalisation of $258m.

Macquarie & UBS were the joint lead managers to the float and as it stands, Macquarie remain the most bullish on the stock with an optimistic $2.30 price target…hmmm. At the time of listing, they were expected to do earnings of around 20cps and today that number is around 15cps.  

ASG Earnings Expectations (red line) share price (white line)

This is the cheapest stock in the sector trading on just 7x expected earnings, however the market is factoring in flat earnings for FY19 relative to FY18, a tough ask if the continued decline in national vehicle sales continues. Liquidity is an issue and to me, earnings expectations still remain too high which is artificially compressing the PE.

MM is negative ASG.

Autosports Group (ASG) Chart

4 Motorcycle Holdings (MTO) $2.40

The smallest of the 4 with a market capitalisation of $148m, this is a similar business to the ‘car yards’ discussed above but selling motorcycles instead with 34 dealerships across NSW, QLD and the ACT. Just like new cars, new motorcycle sales have been falling for some time, with the latest data showing a drop of 13% in the first quarter of FY19. This business has a longer track record starting out in 1989 however Morgan’s listed them in 2016 at $2.00. They had a very strong first year as motorcycle sales rocketed nationally, getting to a high of ~$5.20, only to give most of those gains back over the last 12 months.

Again, the stock is cheap however the earnings remain under  pressure.

MTO Earnings Expectations (red line) share price (white line)

Technically, a test of the $2.00 listing price would be interesting

MM is neutral  MTO however a test of $2.00 support could appeal

Motorcycle Holdings (MTO) Chart

Summary

This is clearly a cheap sector and rightly so given the trends in terms of macro drivers and specific company earnings. However, vehicle sales are very cyclical and they will turn, buying in a cyclical downturn and being patient for a cyclical upturn is how Nick Politis is clearly playing it.

Two of the businesses outlined above floated in 2016, the peak of new vehicle sales in Australia. The private owners of those businesses were sellers of strength, or in other words, they sold into the cyclical upturn, the question now is, how much weakness is enough in this current cyclical downturn?

MM are neutral / negative the sector short term however MTO & AHG would be our preferred exposures into further weakness .

New CBA Hybrid – looks ‘relatively’ cheap

CBA have recently launched a new hybrid being the CommBank PERLS XI Capital Notes (CBAPH). It’s being issued to replace the existing CBAPC. Distributions are fully franked, paid quarterly at a floating rate of between  3.70% - 3.90% per annum above the 90 day BBSW rate.

When looking a security like this we review the structure, term, credit quality of the issuer and whether or not the rate stakes up relative to these factors;  

Structure; Tier 1 hybrid with all the usual conditions – no issue with this

Term: First call date on 24th April 2024, which is shorter dated than some recent issues – no issues here

Issuer; CBA are sound – no issues here

Rate; Relative to recent issues plus current trading margins for similar securities, the CBAPH looks on the cheap side

All in all, this looks like a good value security, the issue is around availability given the reinvestment offer – it will likely be tight.  The bookbuild at Shaw opened and closed on the same day highlighting the demand v availability of stock.  

Have a great day!

James, Harry & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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