Inchcape plc (LON:INCH) is the topic of conversation when Zeus Capital’s Head of Research Mike Allen caught up with DirectorsTalk for an exclusive interview.
Q1: Inchcape, can you talk us through their business model?
A1: Inchcape is a very unique business, it’s vertically integrated, end-to-end, global automotive distributor but it also is a retailer as well. It employs over 18,000 people and operates across 32 different global markets.
The business is very well invested, an excellent track record of delivery, good management team and some of the brand partnerships go back over 50 years in some cases. They work with OEM’s from product design through to retailing and aftersales services and they can provide a unique end-to-end solution.
In terms of splits, it is very much a distribution business now with over 80% of its EBIT derived in that area with about 20% in retail and we would expect the mix towards distribution going forward. We believe that’s the right strategy as it will continue to enhance the free cash flow generated and return on investment capital generated as well.
Q2: So, what are the key investment attractions for investors?
A2: As we said, they do have a very unique business model and they operate in diversified markets as well which I think will help in terms of global uncertainty. In terms of growth strategy, we think it’s quite exciting in terms of operational improvement, we would expect some more consolidation as well and they’ve got a good track record of innovation.
I think a real key point is capital allocation so if you look at this business, they’ve returned over a billion back to shareholder since 2011 and since the new management joined in 2015, those returns have accelerated as well. Some of the M&A acquisitions that they’ve done, they’ve spent about £450 million since 2016 and bought some businesses in new territories there as well.
I think the other thing that we kind of draw attention to for investors is free cash flow yield will be in excess of 10% based on our 2019 and 2020 forecasts. The return on capital employed, pre-tax, is approaching 30% or on a post-tax basis, still over 20% which we think is a market quality for this business yet given the recent turbulence in the stock market, the share price is back at 2013 levels, we have seen a sharp derating in the shares of late.
Q3: Just talking about the forecasting, there’s so much going on, it must be quite difficult to forecast for a company like that? What approach do you take?
A3: In terms of our forecasts, we’ve been fairly cautious, and our forecasts are towards the lower end of the consensus range. We do take a bottom-up view in terms of each market and each division and we’ve been a bit more cautious on the UK, parts of Asia and Australia. We have factored in £100 million share buyback into our forecast from 2019 and we’ve got confidence in that given the consistency of the capital allocation strategy. However, we’ve not factored in any M&A into our base forecast and I think given the balance sheet having a cash building up from 2019, I think we are likely to see M&A which would support those forecasts as well.
Q4: I think you touched on this earlier but what are your thoughts on Inchcape’s current valuation?
A4: So, the valuation for us is compelling. The shares are on sub 9 times earnings from 2019 onwards, EV/EBITDA of just over 5 times, we’ve got a dividend yield which we’ve assumed is flat in the forecast period of about 5%.
We think that’s at odds given the free cash flow, the returns on capital that I alluded to before and the strong execution and capital allocation delivered to date.