Kicking the tyres on super-cheap Automotive Holdings

For many years now, Australia has been without a locally-owned major passenger car manufacturer.

We certainly have manufacturing and assembly plants belonging to the global automotive giants, but to invest in these businesses, you had to head to American, Asian or European exchanges.

One way Australian investors can have access – of sorts – to the automotive sector is through car dealer and logistics provider Automotive Holdings Group (ASX: AHE).

Consolidation and growth
With fewer international manufacturers and brands (through mergers and rationalisation), dealers have responded through a consolidation of their own – scale that provides increasing clout at the negotiating table with their suppliers, and greater economies of scale at an operational and marketing level for consumers.

60 years old, Automotive Holdings Group (AHG) has emerged from its roots in WA to develop a significant presence on the eastern seaboard of Australia and into New Zealand. The company has built an impressive network, covering over 100 dealerships, and almost all of the top car brands including volume brands such as Holden, Ford and Toyota and prestige marques like Porsche and Bentley.

The company also has a logistics division, with operations in automotive logistics (vehicle and parts distribution and storage) as well as a refrigerated transport business.

The Pac-Man of car dealers
AHG has primarily grown through acquisition, having bought dealership businesses in New South Wales, Queensland, Victoria and Auckland, New Zealand in the past 5 years, but also develops so-called ‘greenfield’ sites from scratch when the opportunity presents. It also acquired an additional logistics business earlier this year.

In a very competitive market, the company plans to continue to grow by acquisition, and is obviously reliant on the demand for cars and trucks by Australians.

Execution is king
AHG has form on the former, but it isn’t without blemish. After a buying spree primarily in 2006 and 2007, the company has struggled to meaningfully grow earnings per share – in part due to continual share issuances which have taken the share count from around 140 million in 2004 to 260 million in 2011 – not far off double in 7 years.

Accordingly, while total profit has grown, EPS has lagged considerably. In the company’s defence, consumer confidence has been lacklustre in recent years, and the last few years may not be representative of the future. Additionally, while shareholder dilution is never welcome, the company’s balance sheet is better placed than if it had only used debt to fuel the acquisitions.

At the mercy of consumers
On the second front – demand for motor vehicles – the immediate past has been good news for new car dealers. The Australian Bureau of Statistics new car sales figures have shown robust demand, not withstanding a dip in May and June of this year. ABS statistics show that new car sales peaked (in monthly sales) towards the end of 2007, and had a tough 2008, before beginning to recover. Last month showed the highest trended sales figure in almost 4 years.

Encouragingly for current and potential investors, insiders own a significant portion of the company, and while AHG hasn’t been shy of issuing new shares, the company’s current debt load is quite small relative to shareholders equity and the interest bill is manageable.

Risk and return
An investment in AHG is not for the faint-hearted. The company’s stated strategy of growth by both development and acquisition means you know what you’re getting, but execution risk and the chance of management over-paying for an acquisition are ever present.

Equally, the company is at the mercy of the vagaries of consumer demand for new cars, and any economic setbacks have the potential to stall growth in the short and medium terms.

That said, if AHG can turn top line growth into consistent EPS gains (and it plans to use a sale and leaseback strategy to limit the need for additional funds), the company might deliver market beating returns.

Foolish take-away
With a price/earnings ratio of 8.8, a dividend yield of 8.7% fully franked and trading at only a small premium to book value, AHG’s current price isn’t demanding – but nor has its historical performance been stellar.

If you expect the Australian economy to continue its recovery, and consumer confidence to return (and lead to higher new car sales) AHG may well be one for your watchlist. If you’re a bear, this might be one to avoid.

I’m not ready to buy just yet, but having kicked the tyres and taken it for a test drive,  this is one company I’ll be keeping a close eye on for signs that it is turning straight-line speed into success on the investment podium – shareholder returns.

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Scott Phillips is The Motley Fool’s feature columnist. Scott doesn’t own shares in any company mentioned in this article. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.


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