ValueLine: Vroom vroom

PORTFOLIO POINT: With more than a million new cars expected to be sold in Australia this year, which companies might benefit?

My analysis of Carsales.com in last week’s column (click here) generated a great deal of interest so this week I thought it might be an idea to delve deeper into the automotive sector and see if there are any other opportunities in the space. As I mentioned, Australians are expected to buy more than a million cars this year.

The Federal Chamber of Automotive Industries (FCAI) has since confirmed that its previous estimate of 980,000 units for 2010 was understated. After a record September figure, FCAI has said sales may hit 1.1 million units, surpassing the pre-GFC record.

Several factors have contributed to the boom in car sales: consumer confidence, low unemployment, stimulus-package tax-breaks, a 50% cut in tariffs at the start of the year, and a strong Australian dollar allowing retailers to cut prices.

Year-to-date car sales are up 14.5% on a year earlier and if the FCAI’s forecasts materialise, Australia’s car industry will grow by 17.36%. This will be only the third year in which more than a million cars have been sold.

The growth in car sales is encouraging for some of our listed car yards and I touched on two very different examples last week – Carsales.com.au (CRZ) and Automotive Holdings (AHE) – which could benefit from an ever-expanding national car fleet.

But your investment options don’t end there. The strong volume of transactions in automotive sales is also encouraging for the “aftermarket” parts and equipment sector, so this week I’m looking at two listed businesses that provide aftermarket parts to our booming car industry and which may also benefit from more new wheels being on the national road.

The first is ARB Corporation, which carries an MQR (Montgomery Quality Rating) of A1. ARB is solely focused on manufacturing and distributing 4WD accessories, including fuel tanks, rear steps and rear wheel carriers, bull bars, roof racks and snorkels.

Its focus is opportune, given 4WD-style wagons and compact SUVs have seen leaps in demand of 36.6% and 53.8%, respectively, on this time last year.

The second company is Super Cheap Auto (SUL). It carries an MQR of 'A2’ and is another high-quality business. Prior to 2005 Super Cheap Auto was focused on retailing auto parts and accessories, tools and equipment but it has since undergone significant change.

Retailing auto-related products remains its core business, but Super Cheap Auto has also expanded into selling boating, camping, outdoor entertainment and fishing equipment and apparel, through the BCF (Boating Camping and Fishing) brand.

Its recent acquisition of Ray’s Outdoors has also entrenched this direction while ensuring that you do not receive 100% exposure to the car industry and can expect some earnings diversification. Another change has been a move into retailing and distribution of bicycles and bicycle accessories through Goldcross Cycles, which is the group’s only loss-making division and an excellent example of “diworsification”.

Bike sales exceeded car sales for the first time last year, but with the Australian dollar high and with websites such as the UK’s Chain Reaction Cycles offering cheaper prices and free global shipping, selling bikes through retail stores is becoming more problematic.

So which business would ValueLine consider for exposure to the Australian auto aftermarket sector?

-On the grid
		Fundamentals		Valuation
Company	ASX	ROE (f) 2011	Net debt/equity (a) 2010	Current price	2011 (f)
ARB	ARP	30.16%	-18.81%	$7.38	$7.53–8.01
Super Cheap Auto	SUL	18.84%	29.14%	$6.68	$4.87–5.08

Comparing each of the business’s underlying fundamentals reveals one company stands head and shoulders above the other.

ARB’s forecast return on equity in 2011 of 30.16% and an average of 28.18% since 2001 is a far superior measure of business performance to Super Cheap Auto’s, which is forecast to be 18.84% and has averaged 17.79% since 2004.

Such high returns by ARB is a remarkable achievement by management, who still have a significant amount of their own wealth tied to the businesses performance. Generally, although not always, this ensures decisions are made with shareholders’ interests at heart. ARB is also debt-free. The net debt to equity figure of –18.81% indicates a net cash position.

Super Cheap Auto on the other hand has $78.8 million in net debt, or a gearing level of 29.14%. Given the cash flow of Super Cheap Auto, this is not demanding either but is simply not as attractive as ARB’s. And remember that ARB’s return on equity is also superior.

The superior business performance of ARB is reflected in the change in intrinsic value. ARB’s intrinsic value has risen by almost 22% per annum over the past decade, while Super Cheap Auto’s intrinsic value has risen by 10% per annum over the past five years. Neither company has been in the habit of annually issuing copious quantities of dilutive shares, with the exception of an acquisition-related share issue by Super Cheap Auto last year.

Finally, ARB is currently offering a small discount to my assessed valuation range for 2011, while Super Cheap Auto looks expensive. Therefore, on the three metrics – forecast ROE for 2011, actual net debt levels for 2010 and my forecast valuation – ARB is the clear standout.

The only element lacking for ValueLine to make an investment decision is the requirement of a more meaningful discount. ARB remains another A1 business with bright prospects that remains on the watchlist for now.

-The ValueLine portfolio, as at October 12, 2010
Company	Purchase /June 30	Price today	Est value**	Margin of safety	Shares owned	Invested capital ($)	Capital value ($)	Divs rec	Total return
JB Hi-Fi	19.07	20.25	24.44	14.1%	845	$16,106	$17,103	$0.33	7.92%
Cochlear	74.32	68.26	52.89	-35.5%	102	$7,574	$6,957	$1.05	-6.74%
CSL	32.58	32.2	31.05	4.8%	163	$5,323	$5,261	$0.45	0.21%
Woolworths	27.02	28.98	26.98	-0.8%	206	$5,554	$5,957	$0.62	9.55%
Reece	24.20	22.5	20.8	-15.6%	236	$5,723	$5,321	$0.00	-7.02%
Platinum Asset Mgt	4.68	4.86	4.95	17.5%	854	$3,996	$4,150	$0.14	6.84%
Matrix Engineering	3.42	5.22	6.02	13.3%	2,047	$7,001	$10,685	$0.00	52.63%
CommBank	48.64	50.45	51.19	12.4%	215	$10,458	$10,847	$1.70	7.22%
Cash						$50,267	$50,267	$895.17	1.78%
Total Return ($) 2011						$112,003	$118,515	**	5.81%
Return on Invested ($) 2011						$61,736	$67,353	**	9.10%
All Ordinaries (pts) 2011						4324.8	4686.3		8.36%
Total Return ($) 2010									12.79%
Return on Invested ($) 2010									27.59%
All Ordinaries (pts) 2010									9.69%
* Latest Intrinsic value update 31 Aug 2010
** Includes Dividends

Roger Montgomery is an independent analyst and author of Value.able, available exclusively at rogermontgomery.com.