AMA Group’s executive chairman and chief executive, Ray Malone, looks more relaxed now than he has in years.
That might surprise you, considering AMA has just agreed to spend up to $100 million on its biggest competitor, Gemini Accident Repair Centres, at an earnings before interest, tax, depreciation and amortisation (EBITDA) multiple of up to 7.5 times. The price tag has some investors concerned about the risk of overpaying for growth.
But at last week’s Australian Microcap Investment Conference, Malone explained his relaxed demeanour as he briefed investors on AMA’s progress. As Malone discussed AMA’s strategy and its impact on the company, we gained plenty of comfort in this stock’s prospects and its significant weight in the Growth First model portfolio.
A transformational acquisition
We already knew that buying Gemini would make a step change to AMA’s revenue. The deal has taken AMA from a group that brought in $42m of revenue in vehicle panel repair in FY15 to one which should bring in $250m of panel revenue in FY16. But now we know that the bigger AMA gets, the easier its job could become.
Malone looks relaxed now because bringing Gemini into the fold takes most of the competitive pressure out of the game. AMA has now absorbed five of the groups that sought to consolidate the panel repair industry over the past few years. The firm’s main challenge now is what Malone calls ‘the good stuff’ – integrating finance, IT and HR systems and processes across the group, stoking organic growth and picking up slippage on procurement costs.
Malone is personally overseeing AMA’s procurement efforts and is already finding the synergies with Gemini are significant. For example, some of the Gemini sites lack natural gas and use LP gas in bottles. Between LP gas and insurance, AMA found more than $400,000 in annual cost savings in the two weeks after acquiring Gemini.
These early wins give us confidence that AMA can find significant cost savings at Gemini and other newly acquired businesses while it grows revenue across its expanding network. Scale benefits should help to keep AMA competitive while it boosts shareholder value.
A long runway for growth
Panel repair is a highly fragmented industry, and with Gemini under its belt, AMA has entrenched its position as one of the most influential players.
The Australian panel repair industry once boasted 6,000 body shops. As motor vehicle insurers have increasingly valued efficiency and reliability, some of the smaller and more colourful operators have left the industry, shrinking the number of body shops to around 3,500. According to Ray, this figure will sink to fewer than 1,000 centres.
Malone has observed that 80 per cent of panel shop owners are over the age of 60 and lack succession plans. Many own their factories and want only to be part of a larger group and view AMA’s position and reputation in the industry as a real drawcard.
I believe that the enlarged group is now looking at an acquisition pipeline of around $200m in revenue. Malone expects to have brought a minimum of $50m and more likely closer to $100m of that revenue into AMA by the end of 2016 on an annualised basis.
As a multiple of FY15 revenue, that target sounds optimistic, but Malone has a strong record of accomplishment when it comes to negotiating deals on time and in shareholders’ interests. The latest evidence of that record came on October 20 when AMA announced that it had revised and finalised its arrangement for acquiring Woods Accident Repair Centres.
This deal originally featured an earn-out arrangement which saw AMA stand to pay Woods more than $8m. Under the revised arrangement, AMA will now pay just $2.05m for the acquisition of Woods and its majority stake in the Trackright business. This is a favourable result that could represent a purchase price of less than 1.5 times FY16 EBITDA.
With around $8m in the bank after its recent capital raising and after paying its FY15 dividend, AMA can continue purchasing smaller competitors at a rapid rate at very cheap earnings-accretive multiples. The firm can pay cash for the right deals and is also negotiating a debt facility which could provide as much as $40m at competitive rates. It’s a wonderful turnaround from when AMA had to pay down debt to regain credibility with lenders.
The sky’s the limit
Although AMA has grown rapidly, it retains significant scope to continue its expansion as it consolidates the panel repair industry. Ray’s aspirational target is to grow the AMA network from 71 shops at present to around 270 shops.
This could triple AMA’s revenue from current levels, but would still see the group taking far less than 20 per cent of the $5 billion panel repair industry.
As this consolidation plays out, AMA will also prioritise vertical integration opportunities. There is increasing scope for AMA to buy trusted suppliers of paint, radiators, headlights and other components. This could expand the revenue opportunity from AMA’s panel repair business by as much as 50 per cent. It’s difficult to predict the timing or scale of such integration, but it remains a rich source of potential profit – as does the prospect of expansion into markets overseas.
Roll-up growth stories only boost shareholder returns when a company buys scale and then forces real cost savings. AMA’s management are keenly aware that the market will judge them on their ability to trim those costs.
The Woods acquisition alone brings the potential for material annual cost savings. Combining Woods’ headquarters with those of Gemini should save several million dollars per year.
Not all of the synergy benefits will fall to the bottom line, but in light of the positive early report on AMA and Gemini’s integration, we believe the firm can convert revenue to profit better than the market is currently pricing in. We update our forecasts, factoring in modest revenue growth and margin compression as AMA scales up. Our estimates could see AMA earn more than $30m of EBITDA in the current financial year.
We will need to see more detail around Gemini’s accounts to accurately forecast earnings for FY16 and beyond, but on the basis of our estimates, AMA looks reasonably valued with a market cap now of just over $400m. As investors become increasingly comfortable with AMA’s pace of consolidation, the firm’s shares could re-rate upwards.
Raising our estimates
AMA Group has made a promising start toward integrating the larger Gemini Group into its smooth operations. Although execution risks remain, we are comfortable with Malone’s record of accomplishment.
We reiterate our buy recommendation and raise our valuation to $1.07 per share, representing a slight multiple expansion to 26 times our FY16 forecast earnings per share. After AMA’s recent strong run, the stock is a buy on weakness. Taking a one to two year view, we see opportunity for significant further earnings growth and share price appreciation as AMA consolidates the Australian panel repair industry.
To see AMA Group's forecasts and financial summary, click here.