Investing in small caps is more a bet on management than anything else, and buying shares in AMA Group (AMA) makes for an interesting proposition.
This is because the automotive parts and services group’s head, Ray Malone, breaks the mould of what could be described as the typical chief executive.
Not that there are any real stereotypical leaders in small cap land, although many are suit wearing, business trained and polished communicators.
I’ve never seen Malone in a suit, and I wonder if he owns one. This isn’t to say he isn’t business savvy, although he received his education from “the school of hard knocks”. I profiled Malone in November last year, as I was fascinated with the man who had overcome his disadvantaged background.
Malone is autistic, was orphaned at 11 and had to fend for himself at 16 by taking on a spray painting apprenticeship. He worked 80 hours a week for the next 10 years to scrape together enough savings to open a panel beating shop with two of his friends. He eventually bought them out.
That business was subsequently sold to AMA Group, and Malone became the group’s saviour years later by taking over the reins from the previous managers when it was facing bankruptcy.
The repaired AMA Group now finds itself in a sweet spot due to changes in the industry, with insurers forming their own network of authorised repairers to control costs. AMA Group is an approved repairer for most of the major insurers, such as RACV, while the majority of its smaller rivals are not.
This leaves AMA Group well positioned to benefit from the inevitable consolidation of the fragmented industry, and it is the latest takeover of Melbourne-based Repair Management Australia that is driving an expected 35% increase in revenue to $91.3 million in 2014-15.
There is a lot of capacity for the group to grow via acquisitions as Malone has a considerable war chest to fund takeovers, and he isn’t afraid to use it. AMA Group has an under-geared balance sheet, with a forecast current year net debt to equity ratio under 4% and cash generative businesses. It’s not just the panel beating business that has room to grow.
In fact, panel beating is not even AMA Group’s biggest division by revenue – at least not yet. The division is expected to report sales of $15.4 million from the last financial year compared with $27 million from its vehicle protection business, which essentially manufactures and distributes bull bars.
Sales growth in vehicle protection got a big boost from last year’s acquisition of rival Custom Alloy, which is forecast to add around $12 million in annual revenue and $1.5 million to earnings before interest and tax.
|Divisional revenue forecasts for AMA's divisions (A$'000)|
|FY||Vehicle protection||Panel repair||Accessories distribution||Cable & accessories||Transmission Repair||Other||Total||Growth|
But not every division is firing on all cylinders. Its Western Australia-exposed accessory distribution business and its brakes business are being weighed down by the mining slump. The silver lining is that these divisions constitute a relatively small proportion of group revenue.
Malone won’t say what’s next on his shopping list, but it’s clear that he’s got options and that’s why I believe my earnings growth forecasts for the group is a little too conservative – although this is always a good starting point when looking at small caps.
Based on my price target of 36 cents and fully franked forecast dividend of 1.68 cents a share for 20-14-15, there is another 28% upside to the stock if you included franking credits. AMA Group pays dividends once a year around November.
I am forecasting earnings before interest, tax, depreciation and amortisation (EBITDA) to surge 80% to $15.9 million in the next three years before Malone retires. The group’s chief operating officer, Ray Smith-Roberts, is being groomed to succeed Malone.
But the group’s full-year result announcement later this month won’t show much of this growth due to weakness in WA and the costs impost from the buyout of Custom Alloy. Acquisitions take time to bed down and it is normal to see a quicker rise in costs compared with a ramp-up in revenue over the shorter term.
This is why I am anticipating a close to 150 basis point (1.5 of a percentage point) squeeze in EBITDA margin to around 13% for 2013-14.
Further, higher tax payments due to timing issues will also likely crimp on its bottom line. On my conservative estimates, net profit will come in at $5.5 million compared with last year’s $7.4 million.
However, and more importantly, I expect to hear upbeat commentary from management regarding the current year’s outlook, and any near-term dip in the share price should be regarded as a buying opportunity.
There are execution risks to my upbeat longer-term forecasts, but Malone’s straight talking and down-to-earth mannerism (along with his track record) gives me confidence that he will deliver to expectations. After all, Malone tells me he lives life on two key principles. The first is commitment and focus.
“The other is to work like a Trojan,” says Malone. “I don’t muck around.”
Click here to see AMA Group’s forecasts and financial summary.