Automotive component supplier ARB Corp ((ARB)) continues to be impacted by a slowdown in vehicle sales and weakness in the Australian dollar, which signals to brokers there will be pressure on margins over FY20.
While sales growth improved in the second quarter, this was more than offset by the headwinds to margins, and the company’s latest net profit guidance of $25m is below broker forecasts. The company has warned its first half revenue will be up 7% while a depreciating Australian dollar against the Thai baht, where manufacturing is based, has meant net profit will be down -7.4%.
Credit Suisse observes the stock has generally withstood profit warnings quite well in the past, and there are some positives that could drive a return to earnings growth if these indeed materialise, including a recovery in sports utility vehicles and 4WD sales, a reversal of the strength in the Thai baht and/or a game-changing acquisition.
There is a strong track record of earnings growth, Ord Minnett agrees, with half-year underlying net profit growth averaging 11% over the past 15 years. Yet while some investors may focus on the strong top-line growth and believe the currency headwinds are temporary, the broker requires further details in order to more confidently analyse the main drivers, and implications for future margins.
ARB has confirmed first half sales growth of 7.1%, an acceleration from the 5% growth posted in the first quarter. This suggests to Wilsons domestic sales are broadly stable despite a softening in the 4WD segment of new vehicle sales. It also points to stronger sales growth in export markets.
Wilsons was encouraged by the sales growth in the second quarter and expects this should be supported by new products to be launched in North America from the second half.
The valuation is sufficiently attractive to support an Overweight rating and the broker, not one of the seven stockbrokers monitored daily on the FNArena database, has a $19.65 target. The database has four Hold ratings. The consensus target is $17.99, suggesting -3.6% downside to the last share price.
Ord Minnett does not envisage material upside to the share price in the near future, noting the company highlighted uncertain economic conditions. As is the case for many automotive parts suppliers in Australia, price rises are required to offset cost inflation. The company owns much of the manufacturing value chain but achieving supplier-led cost reductions is much harder, the broker adds.
Credit Suisse suspects the stock will be range-bound, pointing out the company has incrementally pushed more production into Thailand over the past 10 years so exposure to the baht has increased materially. On its calculations, the Australian dollar has declined more than -20% against that currency over the past two years. Still, the balance sheet is healthy and acquisitions remain a possibility.
OEM Growth
Citi points out prices increased by 2.5% in the first half which could have helped sales growth accelerate in the second quarter. The broker expects sales growth will continue improving as original equipment manufacturer (OEM) sales are likely to be underpinned by new contracts and the renewal of existing contracts.
Exports may also benefit from the lower Australian dollar. Nevertheless earnings (EBIT) margins in the second half are expected to decline to 15.5% because of the currency depreciation and an increase in OEM sales, which have lower gross margins. Subsequently, Citi expects margins will expand over FY21 and FY22 driven by increasing scale in offshore markets and efficiency gains from the new Thai warehouse.
Citi expects ARB is able to drive medium-term earnings growth because of an increasing consumer preference towards sports utility vehicles and 4WD. There are also potentially new opportunities from OEMs.
