Motorcycle Holdings (MTO) caught our attention recently as sustained weakness saw its shares approaching lows not seen since this time last year. Now trading at $3.10, MTO currently trades 40% below January highs of $5.20.
This is interesting to us for several reasons:
- MTO is a roll-up business with plenty of scope for acquisitive growth in Australia’s highly fragmented motorcycle dealership market. Out of about 675 dealership operators, only three have networks of 5 or more dealership locations. MTO is the largest with 28, which the company has gradually accumulated since its founding in 1989.Arguably, MTO is the most skilled and experienced player in terms of acquisitions and integrations, so it is reasonable to expect it could be substantially larger in 10 years’ time. Against anaemic new motorcycle sales growth, which has hovered between 95,000 and 110,000 in recent years, MTO can manufacture growth above 10% simply by adding new dealerships. Value is created for shareholders via multiple arbitrage, whereby acquisitions of private operators are made at substantially lower multiples than MTO’s earnings multiple on the public market.
- In October last year MTO completed a transformative acquisition of motorcycle accessories wholesaler/retailer Cassons, which more than doubles earnings on a proforma basis – that’s before potentially material revenue synergies from cross-selling, or cost synergies derived from increased buying power and consolidated head office and administration functions. All else equal, the acquisition is expected to lift earnings by 26% on a per share basis.
- Assuming normal, albeit choppy, per annum sales, MTO should generate net profit of over $20m in FY19 (reflecting the first full year of contribution from Cassons). This means MTO’s current market capitalisation of $202m is just 10 times base-case FY19 earnings. As some readers would appreciate, earnings multiples between 9 and 11 times are a short-hand benchmark for zero or low growth. Given points 1. and 2. supporting strong growth potential, MTO could well be materially undervalued.
Although there’s a strong case for an investment in MTO, in our view the combination of debt and the pro-cyclical nature of motorcycle sales place the company in a somewhat precarious position.
One of the features we strive to preserve within the Clime Smaller Companies Fund is balance sheet strength across our holdings, which acts as a buffer against setbacks but also capacity to capture opportunities as they arise. Following the Cassons acquisition MTO had net corporate debt (excluding bailment finance for motorcycle inventory) of $46m as of 31 December, up from $11m at 30 June. MTO’s debt levels, while not extreme at about 1.5x FY19 EBITDA, could make things more difficult if an industry downturn were to occur over the next couple of years.
We don’t have a crystal ball so we’re more interested in protecting capital by positioning for a potential downturn rather than predicting if or when one occurs. Although Australia hasn’t experienced a recession in over two decades, the tide will at some point turn against Australian consumers, who have accumulated record debts.
The chart below in effect illustrates the discretionary nature of motorcycle sales. During the GFC sales in the US plummeted from around 1.2 million to less than 0.5 million and haven’t recovered. Australian and US consumers are different, however the effects of debt are universal, as are spending habits for items such as motorcycles.
Figure 1: New motorcycle sales (1000’s), USA (1990 – 2016)
Australian new motorcycle sales look stable by comparison, but this could give the illusion of mean-reverting annual sales volumes. We’d argue it also reflects relatively calm economic times.
Figure 2: New motorcycle sales (1000’s), Australia (2009 – 2017)
Source: MTO, Clime
On a base case scenario of annual industry sales continuing at around 100k units, MTO screens as modestly undervalued against our FY18 valuation of $3.60. However, the downside risk is perhaps not fully reflected in the price so for now we’re more comfortable watching from the sidelines.