Founded in 1958, GUD Holdings (ASX: GUD) operates in two activity areas, the automotive aftermarket and water products, two very distinct markets. The company is well-established in Australia and New Zealand and holds a market leadership position in all the business segments it competes in. Hence, the group owns an unrivalled stable of brands such as Ryco, Wesfil, Narva, Projecta, DBA, Injectronics, Goss and Permaseal, and in the water business, the highly respected Davey brand.
Tailwinds in the automotive aftermarket makeup for water business’ headwinds
We can say that recently, investors’ sentiment reflects quite accurately the business performance, hence GUD stock price has been trading sideways since the beginning of this year between $10.85 and $13.69 per share. Around May we have even witnessed steady volume attesting of the good reception from the investors following the release of GUD’s trading update on the 5th of May 2021. According to the release, GUD did quite well during the third quarter with the company’s performance in line with its guidance. The automotive aftermarket has been supported by strong workshop end-user demand, which has underpinned year-to-date organic sales growth of 15%. Furthermore, the macroeconomic drivers remain positive for the sector with used vehicle volumes and values on the rise. We also see an anticipated rebound post-COVID, with mobility at strong levels such as domestic tourism with private vehicles due to aversion to public transport. On the flip side, some challenges are to be expected such as a decrease in new vehicle supply or even interruptions due to microchip shortage. However, overall, we think that the automotive aftermarket outlook is relatively positive in the medium term.
Accordingly, we are convinced that GUD will have the ability to grow further in line with the automotive sector which is on the pathway to recovery. Thus, during the first quarter of this year, new light-vehicle sales grew by +13% year-on-year, a remarkable improvement compared to the last quarter of 2020 which saw new light-vehicle sales increase by +8.4% year-on-year. GUD is also in the quest of adding more businesses to its automotive brands’ portfolio. The firm has even stated that there is no shortage of automotive aftermarket acquisition opportunities. As the saying goes “buy the dip”, GUD is currently doing exactly that with the recent completion of its acquisition of the ACAD division of AMA Group with G4CVA in progress. The most recent takeover was announced in March with the acquisition of Australian Clutch Services (ACS).
For GUD’s water business, well, it is not as positive. Thus, year-to-date, GUD’s water business organic sales are only up by 4% over the previous corresponding period and that was mainly due to the pandemic and lockdowns which continue to impact the company’s operations. GUD is attempting to resolve that by ramping up its production to meet its sales backlog which could involve incremental costs such as shift penalties, outwards and export air freight, partial factory closure. All these are nibbling away at the company’s margins. On a positive note, GUD has stated that the company has a strong inventory position to support demand.
As we have mentioned, GUD stock is currently trading in a tight range year-to-date, and we think that it is due to the company’s cost inflation which is a tad above levels flagged with its first-half results – holding its share price back. This is being driven by freight costs and supplier price rise requests, which are under negotiation. Despite this, GUD has positively narrowed its FY21 underlying earnings guidance to an EBIT of $98 million to $100 million, slightly more optimistic than the previous guidance of $95 – $100 million. As the saying goes “cash is king” during times of uncertainty and that is what we like from the company’s cash conversion target of circa 80% to 85%.
We are also not too concerned with the water business underlying EBIT of $2.1 million for the first half of FY21 compared to the $4.5 million of the previous corresponding period. The decline in EBIT of 51.9% is quite significant, however, it is offset by the remarkable automotive business which did 20.7% better year-on-year. It is also worth noting that the automotive business represents 78% of GUD’s revenue.
FY22 outlook: Continuous expansion in the automotive business
GUD’s portfolio is centred on the automotive industry and is developing its water business alongside. We want to emphasise that the automotive business represents a larger chunk for GUD bringing 78% of the total revenue of the company. Throughout FY20, the group has been on the lookout for numerous acquisition opportunities across various automotive product categories. We think that GUD is applying rigorous discipline in its acquisition process out of a thorough analysis of the strategic fit and valuation. Hence, over the last two years, this has proved to be successful for the company as attested by the resilience of the business particularly during the unexpected impacts of the pandemic. Recently, the company has stated its intention to continue its growth initiative in its automotive business segment, however, the firm also indicated its intention to double its effort and make sure of high integration and manage the risk of impairment. GUD remains clear that acquisition opportunities for the automotive portfolio are still available and attractive, however, appropriate caution will be exercised with the prevailing uncertainty.
During FY19, the company presented its growth plan through a focus on five key topic areas:
- Customer relationships
- Supplier engagement
- People cycle planning
- Product cycle planning
- Operational efficiency
Numbers speak for themselves, so far, since FY17, GUD’s plan has shown great results with a strong business foundation that led to solid gross profit growth at a CAGR of 6% and a steady increase in liquidity with working capital growth at a CAGR of 15.6%.
Taking the opportunity to summarise each business, it is clear GUD has been impacted by the COVID‐19 pandemic, although not uniformly across the portfolio, or even within the automotive business segment. Each of GUD’s automotive businesses continues to enjoy a strong and unique market position, with market‐leading brands and a healthy track record of both product, service innovation and pricing power. Throughout FY20 and the first half of FY21, GUD’s brands continue to be demanded by end-users. Hence, the company’s two filtration offerings, with Ryco and Wesfil combined, had 81% of the first-choice recommendation of workshops in a recent survey.
Automotive business exhibits strong sales growth
Wesfil’s strong sales growth was supported by its well‐recognised value‐orientated brand proposition. This was further supported by its comprehensive state‐based customer service and distribution strategies and the ongoing momentum of newly launched incremental product categories.
GUD’s Ryco brand maintained its FY19 sales level despite the unfavourable market condition. However, the demand in the second half was quite variable from month to month with the impacts of large destocking from resellers and COVID lockdown that happened in New Zealand. Ryco maintained the ongoing tempo of filter product releases and saw increasing growth from its catch can products which was the recipient of the AFR Innovation award.
Throughout FY20, the overall filter market was no less competitive, and collectively, Wesfil and Ryco remain proactive in defending their strong market position. On the other hand, the BWI brand experienced a contraction in the top‐line, as the most impacted of the automotive businesses with the shutdown of its offshore markets and slippage in the more discretionary and OEM product channels in Australia. On a positive note, the BWI brand was able to add new customers and helped some existing customers with its own house‐branding programs. BWI was recognised for the new products with several awards and satisfyingly, BWI recorded more than 10% of its revenue in products less than 12 months old.
Along with GUD’s big brands which are Ryco, Wesfil and BWI, DBA, IMG and AAG all delivered strong revenue growth. IMG experienced an uptick in the repair and remanufacturing demand, with record jobs per day and also gained traction in distributing engine management parts to the independent reseller channels, increasing product cataloguing substantially. Furthermore, during the year, the IMG business launched a new website to enable better velocity in the repair process. Regarding DBA brand’s, DBA did pretty well thanks to strong domestic sales and solid growth in the United States, which offset the COVID‐19 impact in Russia and other European countries. DBA expanded its product range with the launch of a DBA branded disc pad program in pursuit of a larger share of the “wheel end” market.
A significant achievement is DBA gaining the R90 certification, an important Economic Commission for Europe (ECE) automotive design standard to enable further Western European market distribution. And finally, AAG delivered strong growth as well, and in fact, saw a stronger demand through the back end of the year as end customers started to consider engine rebuilds with greater intensity. The AAG integration and relocation proof of concept project continued in parallel, although delayed by 3 months again due to practical impacts of COVID‐19.
GUD’s water business is still lagging behind
GUD also spent considerable effort to build a solid foundation for its water business, Davey, to deliver mid-term growth and maintain profitability afloat. While revenue grew modestly, the EBIT was impacted through new product development costs, restructuring and the significant impact of government social distancing measures. Positively, Davey’s farm trials of Modular Water Treatment products (MWT) continue to progress, with sales that have been secured in new applications such as hospital, hospitality, and other agricultural applications. Moreover, Davey sold out its entire allocation in Europe of its new Nipper chlorinator and delivered the launch of the Tank Sense product. We have seen tremendous effort from the company to shift the momentum by diligently executing its strategic plan to optimise its supply chain, accelerate its commercialisation of product innovation and diversify its channels to market. This falls right in time with the drought eased and fires abated, which in our opinion will certainly trigger the start of an infrastructure rebuild, where notably, water pumping is high on the list of remedial repair or replacement.
Strong inventory and good momentum to support GUD’s earnings growth alongside the economic recovery
Since the first half of FY21, we have witnessed encouraging operating performances which continued through the second half. Presuming there is no second-half fiscal cliff or any significant impact from mobility restrictions, conservatively, we expect GUD’s EBIT to stay in line with the first half of FY21. We have also seen the company making sure that it has sufficient inventory levels which is a key to securing near-term sales opportunities. Furthermore, according to our analysis, we expect the inventory turnover to remain relatively stable above 2.15 over the next two to three years. Consequently, we anticipate cash conversion in the 80% to 85% range for the full year and an increase in cash from operating activities at a CAGR of 6.2% from FY21 to FY23.
Growth through three distinct initiatives
Since FY17, GUD has implemented its strategic direction by implementing three distinct initiatives which have proved to be efficient so far:
- Core: The strengthening of GUD business foundation through group-wide initiatives which consists of leveraging long-term supplier agreements in selected automotive categories and improving back-office resources, logistics IT and revenue management.
- Growth: Address individually each brand of the company’s portfolio to develop new organic growth pathways with existing customers. Growth is also related to the development of new products and innovation.
- Acquisition: and finally, secure new customers and categories through acquisition in the automotive aftermarket industry.
Rock-solid financials despite challenges caused by COVID-19
GUD kept up its earnings growth trajectory despite COVID-19 during the first half of FY21. Hence, revenue for the first half increased by 11% to $251.5 million, up from the 3% growth achieved in the prior corresponding period. Reported EBIT increased by 17% to $50.5 million and comprised $1.8 million of significant items associated with the planned closure of manufacturing by AAG and the costs associated with the acquisition of the ACAD business which does not include the Fluid Drive business from the AMA Group. Underlying EBIT of $52.3 million increased by 18% from $44.5 million reported in the first half of FY20. Finally, the underlying NPAT of $32.7 million also increased by 18% year-on-year from the $27.6 million PCP.
GUD has also benefited from the JobKeeper payments of $2.8 million which were more than offset by employee care and financial support programmes and the incremental COVID-19 operating costs.
We also like the company’s cash conversion rate of 91% which reflected the strong collection performance in the period, some early settlements by debtors and higher velocity in stock turns.
Debt-wise, we have seen a decrease in GUD’s net debt of $117.6 million, about $32 million on the first half of FY20 and circa $25 million on the FY20 year-end balance. The result includes proceeds of $74.9 million of equity raised via an Institutional Placement and Share Purchase Plan as well as a net $65.7 million outflow associated with the purchase of the ACAD businesses. Overall, GUD currently has $99.9 million of available debt facilities and is well placed to fund additional bolt-on acquisitions.
GUD is also exemplary regarding its dividend distribution policy. So far, the company delivered a solid dividend yield of 3.22% while maintaining its target cash position. An interim fully franked dividend of 25 cents per share was announced, in line with the prior corresponding period and represents a payout of 76% of the underlying NPAT. While the interim dividend per share is in line with the prior corresponding period, the total cash consideration of the dividend represents an 8% increase for the period given the additional equity raised to support the acquisition of the ACAD businesses.
Overall, the first half of the financial year has been very active in terms of acquisition-related activity and the automotive business has been a stand-out. GUD’s approach to tackling COVID-19 through a “defence and offence” strategy appeared to serve the company well. In addition, during the period we have seen two acquisitions initiatives and the completion of the ACAD transaction. On the other hand, the water business’ performance was not at the rendezvous. The water business brand Davey has been disappointing as COVID-19 impacted demand due to disruption in the export market. In contrast, the sales result for the Australian business has been particularly pleasing with the improvement beginning to yield some positive results. While there have been deferrals of key modular water tenders, we expect that these contracts will contribute positively onward FY22.
Revenue forecast and valuation
Taking into consideration the continuation of revenue growth up 10.7% on the prior corresponding period and an underlying EBIT up 17.6% on the PCP, we have projected a conservative revenue growth at a CAGR of 4.3% for the period of FY21 to FY23. Our view is supported by the recent acquisition of the ACAD division of the AMA Group and the ongoing progress of its fluid drive business along with the Australian Clutch Services announced in March earlier this year. We consider that the strong momentum in the automotive aftermarket will offset GUD’s water business which we think will continue to weigh on the company’s profitability in the near term. GUD’s operating performance is excellent in our opinion, hence we project cash conversion to be ahead of expectation. Furthermore, GUD’s strong cash position has been recently bolstered by the Share Purchase Plan of $75.7 million to fund acquisitions. Approximately 1.88 million new shares have been issued under the SPP in December last year at $11 per share.
With continuous earnings growth and a stable EBITDA margin above 20% is expected for the next three-year period, we believe GUD is adequately valued at its current market price given its P/E ratio of 23 times and EV/EBITDA of 11.9 times. GUD has an EV/EBITDA of 11.9 times, slightly below the broad market at 14.5 times which might provide the company with some room for further growth.
When we look at GUD’s long-term chart, we can see that the uptrend has been interrupted during August 2018 which led to a 44.5% correction from it’s all-time high at $15.55 per share. One of the key levels we can immediately spot on the weekly chart is the $10.85 – $11 confluence zone which acted as a long-term key support level. This level is also the current price equilibrium which coincides with the recent capital raising via SPP with new securities issued at $11 per share. This is a very important level in our view as it will determine GUD’s next move, whether a consolidation at the tip of the symmetrical triangle pattern that will lead to a positive outcome or a capitulation that can send the share price to the single-digit territory. GUD’s volatility is expected to fade progressively, in line with the development of the long-term symmetrical triangle pattern. In theory, the symmetrical triangle is a bullish pattern, hence, we can anticipate a breakout above the current top of the range at $13.69 and see GUD rallies back to its all-time high at $15.55, slightly above our target price of $15 per share. In the meantime, we suggest remaining cautious, as the RSI indicator indicates potential weakness in the near term which can keep GUD’s share price capped under $11 per share.
Volume and momentum
Volume slightly decreases since the last 200-day with the 20-day volume average down by -5.6%. The price action remains neutral in the near term, evolving in a range between $10.85 and $13.69 per share.
- Market participants might be interested to enter at key levels such as $11 and $10 per share.
- Primary target price above $15 per share
- It is recommended exiting the trade below $9.5 per share
GUD has been exemplary in its operating performance during the pandemic crisis. Hence, we have seen the company keeps on its earnings growth trajectory despite the unfavourable economic condition. GUD’s first half of the financial year has been very active in terms of acquisition-related activity and the automotive business has been a stand-out. We have been positively surprised by GUD’s approach to tackling COVID-19 through a “defence and offence” strategy which appeared to serve the company well. Additionally, during the period we have witnessed two acquisitions initiatives and the completion of the ACAD transaction. On the other hand, the water business’ performance was not at the rendezvous. The sales results for the Australian region have been particularly pleasing with the improvement beginning to yield some positive results. GUD’s financials are rock-solid. We like the high rate of cash conversion that the company exhibits and the robust cash position which has been also strengthened by a fund-raising during December last year with the $75.7 million Share Placement Plan. Overall, a solid company that waits to rally along with the long-awaited economic recovery. With another healthy dividend expected, we recommend long-term investors to “Buy”.