Cube Midcap Report (7 Nov) – Aston Martin heading for breakdown? #AUTO #SBRY
Good morning, it’s Roland here with today’s Midcap Report.
There’s a lot of news on the wires this morning from mid cap and larger companies — too much for me to cover all of it. The companies I’m planning to look at are:
Senior (SNR) – trading update
- Aston Margin Lagonda (AML) – Q3 results
- Auto Trader Group (AUTO) – half-year results
Tate & Lyle (TATE) – half-year results
- J Sainsbury (SBRY) – half-year results
Aston Martin Lagonda (AML)
- Share price:432p (+3.5%)
- Market cap: £985m
For Aston Martin CEO Dr Andy Palmer, I suspect that the launch this month of the Aston Martin DBX SUV is expected to be a turning point, heralding a new golden age. Orders will flow, cash flow will improve and the group will be able to repair its deteriorating balance sheet.
The market appears to have some faith in this view. The shares rose in early trade today, despite the group’s third-quarter results showing the group falling to a loss during the first nine months of this year.
It’s true that early reviews of the DBX appear to be promising. And demand for luxury SUVs shows no sign of abating. But in my view, the company is too far down the rabbit hole of financial distress to be rescued by a single model.
At face value, today’s third-quarter results are pretty dire:
Wholesale volumes (the number of cars sold to dealers) fell by 16% during the third quarter, while revenue fell by 11%. Operating profit fell by 58% to £10.5m, pushing the group to an operating loss of £27.2m for the first nine months of the year.
Market conditions appear to be tough. Although retail sales are up by 13% so far in 2019, there have been big falls in the UK, EMEA and APAC ex-China. Without strong sales growth in China and the US, sales would really have collapsed this year:
Management expect to meet existing expectations for the 2019 financial year, but see pressure on volumes continuing to the end of the year. Total wholesales for the year are now expected to be “lower than previously guided, but within the range of market expectations”. That seems a bit evasive to me.
The company is planning “prudently for FY 2020” and will provide a further update with the FY19 results in February.
To me, this all sounds like the company is delaying cuts to 2020 guidance in the hope that a surge of orders for the DBX will offset bad news elsewhere. As you might guess, I’m not convinced by this logic.
Car makers all over the world are suffering from slowing sales. But they don’t all have such dire balance sheets as Aston Martin.
When I last looked at this stock in July, the company’s net debt/TTM EBITDA ratio was 4.7x. Today’s Q3 figures show that this multiple has now risen to 5.5x. This increase is due both to rising debt and to lower earnings.
To the management’s credit, they don’t really try to hide this worrying state of affairs. Here’s a handy snapshot from the Q3 analyst presentation showing how leverage has risen over the last year:
Aston Martin expects a 2019 interest charge of about £83m. To put that in context, Reuters consensus forecasts suggest a net profit for 2020 of £58m. As a general rule, I would say that when interest costs exceed after-tax profits, the outlook for equity holders is poor.
The group’s latest foray into the debt market certainly seemed to confirm my view that this company is deep into junk territory, perhaps nearing distress.
September debt issue
Aston Martin raised $150m of new debt in September, agreeing to pay 12% for notes due for repayment in April 2022. The firm will pay 6% cash interest and 6% PIK interest (Payment In Kind – the interest is added to the debt).
Proceeds from this debt were used to repay £90m of short-term borrowings and to improve liquidity. In other words, the company was converting short-term debt into longer-term debt. I see that as an early sign of financial stress — it’s a bit like paying your household utility bills with a credit card.
The September deal included an option to borrow a further $100m at 15%, also due April 2022. However, this option is dependent on Aston Martin securing 1,400 DBX orders within nine months.
Aston Martin’s lenders are now demanding a painful price to provide fresh cash to the firm. Linking future debt issues to DBX orders also recognises that the company’s financial situation now hinges on the model being a hit.
I’ve no idea if 1,400 DBX orders is a realistic goal. For context, total wholesales during the first nine months of 2019 were 3,939. So perhaps it is possible.
However, even if the DBX is a hit, I don’t think equity holders are likely to see much of the rewards. Aston Martin now has gross debt of over £900m. And despite having completed most of the investment needed for the DBX, capital expenditure is expected to rise in 2020, from c.£300m to <£350m.
This company has gone bust seven times before. I wouldn’t bet against an eighth occurrence. Although I’m sure the brand will survive, I think the shares are best avoided.
Auto Trader Group (AUTO)
- Share price: 554p (+1%)
- Market cap: £5.1bn
If I wanted to invest in the car market, I’d be much more tempted by this stock. Auto Trader has rolled out another impressive set of figures this morning, showing improved margins and overall growth during the first half of 2019:
- Revenue: £186.7m (+6%)
- Operating profit: £131.4m (+9%)
- Pre-tax profit: £127.7m (+12%)
- Earnings per share: 11.1p (+14%)
Note that these are unadjusted (statutory) figures.
The group’s operating margin rose to an incredible 70% and cash flows from operating activities rose by 3% to £132.7m. Although free cash flow was lower, falling from £105m to £81m, this mostly seems to relate to the timing of tax payments. I don’t think there’s anything to worry about.
Rightmove for cars?
In many ways, the firm’s business model seems to echo that of property website Rightmove.
Auto Trader uses its dominant market share to provide a near-essential service to car retailers, who have little choice but to pay what they’re asked. Unsurprisingly, the average revenue per forecourt continues to rise. This figure rose by 7% to £1,951 during the six months to 30 September.
The company says that it has a 75% “share of minutes” among its competitor set. I assume that refers to the amount of time users spending browsing for cars to buy.
However, although monthly visitor numbers rose by 4% to 51.2m, full page advert views per month fell 6% to 233m. I’m not sure if this reflects changes in the level of car buying activity or simply changing browsing habits.
The number of cars listed on the website rose by 10% to 481,000 during the half year, helped by a 30,000 increase in the number of new cars listed — a key area of growth.
Over the longer term, perhaps Auto Trader’s business model will be affected by a shift to self-driving electric cars and wider use of car-sharing clubs. I don’t know. But for now, the outlook seems strong, especially given its expansion into the new car market (Rightmove is doing the same thing with new-build houses!).
Shareholder returns remain a priority and there were £27m of buybacks and £43m of dividends paid during the first half. The group’s average share count has fallen from 1bn to 925m since it floated in 2015, so these buybacks aren’t just being used to offset employee share options.
Auto Trader stock trades on about 25 times 2019/20 forecast earnings, with a dividend yield of about 1.4%. The stock is never likely to look cheap, but I don’t think this would be an unreasonable price to pay for a long-term holding.
J Sainsbury (SBRY)
- Share price: 206p (inch.)
- Market cap: £4.6bn
When companies start their results with a page of “operational highlights” rather than headline financial figures, you can usually guess why.
Scrolling down today’s half-year results from Sainsbury’s tells me that despite “positive momentum” in Grocery and “normalised” comparatives for general merchandise, both sales and profits are still falling.
|H1 2019||H1 2018||Change|
|Underlying pre-tax profit||£238m||£279m||(15%)|
|Items excluded from underlying results||£(229m)||£(172m)|
|Statutory pre-tax profit||£9m||£107m||(92%)|
In my view, Sainsbury’s is still struggling to reach the state of stable profitability that’s already been achieved by Tesco and Morrisons.
Another contrast is that while Tesco and Morrisons have chosen to expand into the wholesale market, Sainsbury’s has chosen to stick with retail and expand into general merchandise through Argos.
Unfortunately, Argos is a low-margin business that faces huge competition on many ranges from online retailers, including Amazon. The evidence so far suggests to me that Sainsbury’s margins have been diluted by the addition of Argos sales. In contrast, wholesale food appears to offer more attractive margins and better growth opportunities.
Too many adjustments? Sainsbury’s has also become heavily reliant on adjusted profits, something that I tend to be wary of. This table shows non-underlying items reported for H1 2019 and H1 2018:
The Property Strategy Programme costs refer to planned store closures announced in September. These are expected to have a total cost of £230m-£270m, although cash costs are only expected to be £30m-£40m.
Cash generation: That brings me nicely onto the subject of cash generation. In fairness, Sainsbury’s cash flow still seems quite good. The group generated enough free cash flow to cut net debt by £367m to £6,778m (including IFRS lease liabilities) during H1.
The group says retail free cash flow — a measure that excludes Financial Services — was £698m during the period, £81m higher than last year. However, this does appear to include distributions from a joint venture with British Land (disclosure: I hold BLND). I’m not sure that property profits should be included in a measure of retail cash generation, but I do respect the group’s strong cash flow.
CEO Mike Coupe is targeting £500m of cost savings over five years, as the integration of Sainsbury’s and Argos continues. If this is possible without damaging sales, then it should help to repair the group’s fortunes and improve margins.
At current levels, SBRY stock offers a tempting 5% dividend yield, but this payout has been cut heavily in recent years. It’s not clear to me how soon the dividend will return to sustainable growth.
Sainsbury’s could prove to be cheap at current levels. But if I wanted a supermarket stock, I would buy Tesco or Morrisons. In such a competitive market, I would not choose to bet on a company which is lagging its rivals and continuing to report falling profits.
I’m afraid that’s all I have time for today. Apologies for not covering everything as hoped.
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