Halfords Group PLC HFD
February 06, 2012 - 1:14pm EST by
puncher932
2012 2013
Price: 327.00 EPS $35.00 $37.00
Shares Out. (in M): 202 P/E 9.3X 8.8X
Market Cap (in $M): 66,054 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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  • Aftermarket Auto
  • High ROE
 

Description

Halfords Group PLC (HFD) is the largest auto parts retailer in the United Kingdom and it also offers car repair services through its network of auto centers.  UK auto parts retail is a very mature and highly consolidated industry, and HFD has lion’s share of sales in that market and no direct competitors.  The company possesses a number of important scale and brand advantages that create a wide moat around its business.  At the same time, HFD trades at an attractive price of approximately 9X NFY EPS and sports a 7.5% dividend yield, which indicate that the stock is significantly undervalued.

Here is a more detailed summary of what makes HFD an attractive investment at the current price:

 

BUSINESS

-          HFD’s significant size enables the company to source its products at a price that would be out of reach for most potential entrants, thus creating a substantial cost barrier to entry.  Further, HFD’s substantial volume enables the company to offer in-store fitting services, which further strengthens the company’s competitive advantage.  A new entrant would find it hard to offer full-blown fitting services from the get-go without incurring substantial losses.  Yet another HFD’s competitive strength is the company’s brand name.  In auto parts retail brand name is a lot more important vs. a traditional run-of-the-mill retail business, because of the needs-based nature of auto parts purchases, which means that for most customers immediate availability takes precedence over price.  As HFD’s name stands for the best SKU range and availability, it makes the company a default choice for consumers who do not mind paying a small premium in exchange for assurance that they will always be able to find what they need.  It would be tough for a potential new entrant to replicate HFD’s reputation for parts availability without incurring substantial cost over an extended period of time.

-          HFD generates significant free cash flow, has limited capx requirements, and enjoys a solid financial condition.  One of the main reasons behind the company’s cash-generative profile is that HFD operates in a highly consolidated and mature market, which means limited growth opportunities.  At the same time, the company’s ample free cash flow enables the company to devote significant amounts of funds to dividend payments and share repurchases. 

-          As a result of the advantages outlined above HFD is able to generate returns on equity in the range of 25-30% while employing a reasonable amount of debt.  As the said advantages are likely to prevent potential entrants from encroaching on HFD’s turf it is likely that the company will continue generating above-average returns over the long-term.

 

MANAGEMENT

-          Historically, management has done a good job on the operating side of the business by augmenting HFD’s scale advantages, making sure the company stays on top in terms of parts availability, and keeping a tight lid on costs.  With respect to capital allocation management probably deserves a B-, primarily because of the purchase of Nationwide Autocentres in 2010.  While Nationwide is a solid business and was purchased at a sensible price of approximately 12X after-tax earnings, it is only somewhat related to the core business of HFD, in my opinion.  On a positive note, it appears that post-acquisition shareholder feedback changed management’s approach to capital allocation.  Within a few months of the Nationwide purchase, management indicated that future acquisitions are unlikely, hiked the dividend, and started an aggressive buyback program.  Therefore, it appears that going forward management might be getting higher grades on the capital allocation front.

 

VALUATION

HFD is selling for approximately 9X NFY EPS, and the EPS figure is probably somewhat below normal given the poor state of the UK economy.  Further, the company sports a 7.5% dividend yield.  Given the quality of HFD’s business the stock represents an attractive investment at these levels.

Catalyst

The sheer cheapness of the stock that trades at a significant discount to its intrinsic value
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    Description

    Halfords Group PLC (HFD) is the largest auto parts retailer in the United Kingdom and it also offers car repair services through its network of auto centers.  UK auto parts retail is a very mature and highly consolidated industry, and HFD has lion’s share of sales in that market and no direct competitors.  The company possesses a number of important scale and brand advantages that create a wide moat around its business.  At the same time, HFD trades at an attractive price of approximately 9X NFY EPS and sports a 7.5% dividend yield, which indicate that the stock is significantly undervalued.

    Here is a more detailed summary of what makes HFD an attractive investment at the current price:

     

    BUSINESS

    -          HFD’s significant size enables the company to source its products at a price that would be out of reach for most potential entrants, thus creating a substantial cost barrier to entry.  Further, HFD’s substantial volume enables the company to offer in-store fitting services, which further strengthens the company’s competitive advantage.  A new entrant would find it hard to offer full-blown fitting services from the get-go without incurring substantial losses.  Yet another HFD’s competitive strength is the company’s brand name.  In auto parts retail brand name is a lot more important vs. a traditional run-of-the-mill retail business, because of the needs-based nature of auto parts purchases, which means that for most customers immediate availability takes precedence over price.  As HFD’s name stands for the best SKU range and availability, it makes the company a default choice for consumers who do not mind paying a small premium in exchange for assurance that they will always be able to find what they need.  It would be tough for a potential new entrant to replicate HFD’s reputation for parts availability without incurring substantial cost over an extended period of time.

    -          HFD generates significant free cash flow, has limited capx requirements, and enjoys a solid financial condition.  One of the main reasons behind the company’s cash-generative profile is that HFD operates in a highly consolidated and mature market, which means limited growth opportunities.  At the same time, the company’s ample free cash flow enables the company to devote significant amounts of funds to dividend payments and share repurchases. 

    -          As a result of the advantages outlined above HFD is able to generate returns on equity in the range of 25-30% while employing a reasonable amount of debt.  As the said advantages are likely to prevent potential entrants from encroaching on HFD’s turf it is likely that the company will continue generating above-average returns over the long-term.

     

    MANAGEMENT

    -          Historically, management has done a good job on the operating side of the business by augmenting HFD’s scale advantages, making sure the company stays on top in terms of parts availability, and keeping a tight lid on costs.  With respect to capital allocation management probably deserves a B-, primarily because of the purchase of Nationwide Autocentres in 2010.  While Nationwide is a solid business and was purchased at a sensible price of approximately 12X after-tax earnings, it is only somewhat related to the core business of HFD, in my opinion.  On a positive note, it appears that post-acquisition shareholder feedback changed management’s approach to capital allocation.  Within a few months of the Nationwide purchase, management indicated that future acquisitions are unlikely, hiked the dividend, and started an aggressive buyback program.  Therefore, it appears that going forward management might be getting higher grades on the capital allocation front.

     

    VALUATION

    HFD is selling for approximately 9X NFY EPS, and the EPS figure is probably somewhat below normal given the poor state of the UK economy.  Further, the company sports a 7.5% dividend yield.  Given the quality of HFD’s business the stock represents an attractive investment at these levels.

    Catalyst

    The sheer cheapness of the stock that trades at a significant discount to its intrinsic value

    Messages


    SubjectRE: questions
    Entry02/06/2012 10:31 PM
    Memberpuncher932
    Here you go:
     
    1) There are two main differencies:
     
    (a) The UK mkt is a lot more mature and consolidated than the US mkt.  Essentially there is just one pure play auto parts retailer left in the UK (Halfords) and it accounts for the bulk of the industry's sales.  In contrast, in the US the mkt is a lot more fragmented, as you have AZO, AAP, ORLY, PEP, and a whole bunch of smaller retailers.  The implication is that Halfords is probably subject to more cyclicality as it cannot keep growing through downturns by grabbing mkt share from smaller less efficient rivals, which is what AZO, AAP, ORLY, etc. were able to do historically.
    (b) UK drivers are less reliant on cars vs. their US counterparts, which means that during economic downturns the degree of resilience of the auto parts market in general in the UK is going to be less than in the US.  During recessions the UK drivers typically cut back on driving and on maintenance somewhat more than the American drivers, as the UK drivers typically are more willing to switch to public transportation.  You can see the evidence of that from looking at the UK car insurance market which is generally less resilient than the US car insurance market.
     
    2) There are no direct competitors - whether public or private.  There are some indirect competitors such as for example Tesco that offers a few overlapping SKUs (a tiny percentage), but its not any more of a competitor to HFD than, say, WMT to AZO in the US.
     
    3) A chunk of "Leisure sales" are really "Car maintenance sales" as they include such things as car seats, rooftop storage solutions, trailers, mobility and safety equipment (classified by HFD as travel soluation).  Some of those items are required in order for you to be able to operate a vehicle.  (For example, you are legally required to keep in your vehicle a first aid kid, a special light-reflecting vest, special signage, and a fire extinguisher, among other items.)  
     
    From what I understand "Leisure sales" margin is quite a bit lower than that of "car maintenance," thereby making its EBIT contribution less meaningful (esp. after adjusting for items that are really related to car maintenance.)
     
    The cycling sub-segment of "Leisure sales" (the other one is travel solutions, which i discussed above) is a pretty decent business with respect to parts + maintenance portion, and the dynamics here are somewhat similar to those of auto parts.
     
    4) Some of the decline is related to customers simply switching to multi-channel (most of which is store pickup I think) from store buying, which really makes no difference.  Some of the decline is related to the weak UK economy that has been mired in a pretty harsh recession since 2008.  Since the first reason is consumers simply preferring a different purchasing mode within HFD, and the second reason is cyclical rather than secular (as long as you do not think the UK will be stuck in a recession forever), I do not worry too much about negative operating leverage over the long-term.
     
    Hope this helps !
     
     
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