AMA Group (AMA) is one of the more intriguing stories in ASX small cap land. It is centred on chief executive and large shareholder Ray Malone, and his vision of benefiting from the consolidation in the automotive panel industry.
With a market cap of $179 million, we think the company will continue to benefit from acquisitions and are upgrading our recommendation from “hold” to “buy”.
This is a company where it’s best to focus on the 2-3 year strategic direction rather than the next reporting period. With $3.5 billion of panel repairs revenue in Australia, AMA, depending on acquisitions, has the potential to increase its panel revenue to around $500m over the next three years.
Wood’s Accident Repair Centres
Last week AMA announced an option to acquire Wood’s Accident Repair Centres (“Woods”) for an initial cash payment of $2m, which is three times current earnings before interest and tax. Additionally, there will be an earn-out payment based on four times average EBIT over the next three years, of which AMA has the choice to pay a mixture of cash and scrip.
The arrangement includes AMA taking over the operations for a six month period with an option to acquire the business at the end of the period. Woods has 14 sites in metropolitan Melbourne.
Woods was one of the early industry consolidators, getting to $30m revenue mainly in Melbourne. We would expect AMA will be able to quickly lift the last reported annual EBIT of $0.67m. Woods deals with the minor insurers, and previously had a relationship with Suncorp. When Suncorp started operating its own panel shops it had a large impact on Woods, as it had to restructure and focus on other insurers.
The acquisition makes sense for AMA with minimal overlap in geographical locations. It also enhances AMA as the largest panel beating operator in Victoria with $80m revenues. Malone will be working hard to fill some of the $50m of unutilised revenue capacity in these Victorian operations.
AMA will be targeting EBIT margins of 10-15 percent for Woods versus the current 2.2 percent. There will need to be a period of restructure as AMA changes the business to preferred supply arrangements. The opportunity to leverage the IAG relationship will also be a benefit for Woods earnings.
We are forecasting an earn-out payment of $8m above the initial $2m payment based on 4 times average EBIT of $2.5m. We are basing this on the head office synergies, procurement and other benefits that AMA has been able to achieve from past acquisitions. But with little details in the announcement, there is significant uncertainty and it could easily range from $4-12m.
The key to Malone’s acquisition strategy is that he knows his operations run more efficiently than smaller competitors. As well as his excellent systems and processes there are large scale benefits in procurement. Malone stated in the announcement that he expects similar synergy and integration benefits from Woods as he has previously achieved.
Because Suncorp is taking a more active role in the industry, IAG and the other insurers have been forced to become more proactive. This has led to a reduction in accreditations with only the best panel shops receiving insurer support.
Suncorp and IAG comprise about 85 per cent of volume, with AMA having a key relationship with IAG.
For the smaller operators who have not aligned with insurers, it is most likely too late, and they will be either forced out of the industry or be acquired.
The only other large scale consolidators are currently Suncorp and Gemini, with Smash Care a smaller player.
Another key element to the strategy is that Malone has worked out that if he can structure deals that benefit both shareholders and the vendor he is more likely to get faster traction with other potential acquisitions. The industry is tight knit and Malone’s credible and trustworthy reputation is proving to be critical.
The earn-out structure with a relatively small up-front payment displays strong faith from Woods in AMA’s ability to achieve efficiency gains and drive value in the combined structure.
The way Malone has generally structured his deals is around utilising existing cash and debt rather than raising equity. As a 24 per cent shareholder, Malone passionately talks about his dislike for unnecessary dilution. Although equity raisings are likely down the track, thus far he has focused on deals that can be funded by debt or free cash flow.
FY15 has been a busy year for AMA and its results will be an important catalyst as it’s the first full year result with the benefit of a number of acquisitions.
We have assumed Woods contributes from January 1, 2016 with revenue only marginally increasing from $30m, and the EBIT margin increasing to 12 per cent by FY18.
Our earnings per share forecasts are 2.7 cents, 3.5 cents and 4.2 cents for FY15-FY17. The price-earnings (PE) multiples on these forecasts (15 times FY16) are reasonable considering the above market growth and return on capital the company is likely to achieve.
We are now also assuming higher medium term growth rates and have increased our discounted cash flow valuation to from 48 cents to 63 cents.
We don’t believe the market has factored in the value of this acquisition and the traction Malone is gaining with his consolidation strategy.
We view AMA as a stock to “buy” on weakness over the medium term as the consolidation strategy plays out. We expect to increase our 63 cent valuation as further acquisitions are announced.
To see AMA's forecasts and financial summary, click here.