ARB Corporation Limited lifts profit 7.6% – should you buy?

On Wednesday this week, ARB Corporation Limited (ASX: ARB) reported its full-year annual results to the market. The key takeaways from the report are summarised here:

  • Total revenue was up 8.4% on the prior corresponding period (pcp) to $361.2m
  • Net profit after tax was up 7.6% to $47.4m on the pcp
  • The final dividend was increased to 17 cents, an increase of 6.2% on the pcp (dividends for the 2015-16 financial year are 31.5 cents in total)

It’s important to note though that this year’s profit result includes the profit on the sale of a property in the USA. Excluding this, the underlying net profit is actually $46.2m which equates to growth of only 4.7%, not the headline 7.6%.

Before going into the detail, it’s important to take note of previous guidance management provided to the market back on 5 May 2016:

Costs associated with the development and production of products for the large number of new model vehicle releases, and the recent expansion of warehouse capacity, will constrain short term profit growth in the current half year [emphasis added].

And that guidance was pretty accurate. By my calculations, the profit growth to 30 June 2016 since the end of the first half was only 3.3% (compared to the profit growth of 14% for the first half), and an increase of only 2% when compared to the same period in the 2014-15 financial year.

At first glance, this is quite disappointing, especially when placed in the context of an average rate of growth in net profit over the last 10 years of 13% per annum. The market though didn’t seem to care too much with a ‘meh’ response sending the shares down only 1.06% by the close of trade on Wednesday.

However, the explanations for this result go back to the May market update, and were repeated again in Wednesday’s report – mainly that sales growth was hampered by the unusually high number of new vehicle releases that occurred almost simultaneously in Australia and around the world. This meant ARB simply could not supply the market in a timely manner (a nice problem to have).

Additionally, supply constraints also include the lack of fitting capacity in many areas where ARB sells its products.

Longer term, the company is dealing with constraints in supplying product to market by:

  • continuing to invest in R&D (development costs were up 40.5% during the year),
  • purchasing a further 55,000 square metres of land adjoining the existing manufacturing facility in Thailand, and
  • opening a sales and distribution centre in Dubai to serve markets in the Middle East

So there’s no doubt in my mind that management at ARB are looking very much to the future and will make the necessary investments today to provide for continued growth in sales revenue and net profits in the years ahead.

One other thing to watch out for in future reporting periods is the increase in inventories, which were up 11.7%. The biggest component of these inventories were finished goods which rose 9.7%. As a one-off, I wouldn’t be too worried, but this is something to keep an eye on in future reporting periods.

Foolish takeaway

ARB is facing challenges with the export sales slowing due to a slightly higher Australian dollar during the year, and lower export orders received from customers operating out of oil/gas-dependent economies.

Despite this though, exports are now almost a quarter of all company sales and were still up a respectable 12.6%.

The future for ARB will consist of growing sales into overseas markets as the company reaches saturation in Australia and a steady flow of new vehicle releases from the major vehicle manufacturers.

As a long-term investor myself, I’m willing to hold my shares for the as I believe management have a clear strategy which they’re methodically implementing over time.

Of course, I could choose to sell some shares in ARB and perhaps continue my exposure to the ‘automotive segment’ by buying shares in AP Eagers Ltd (ASX: APE), or Automotive Holdings Group Ltd (ASX: AHG).

But I think selling shares in ARB would be a mistake today, and if you own shares, I would recommend you continue to hold.

If you don’t own shares, but would like to, I’d hold back. Even by ARB’s standards, today’s price is expensive and there’s a real risk of a negative return in the short term if shares are bought around $18.

At least wait until the trading update at the company’s AGM in October and we’ll see how sales are progressing for the first quarter of 2016-17.

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Motley Fool contributor Edward Vesely owns shares of ARB Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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