NTD - NTAW Holdings

[System]

National Tyre & Wheel Limited is a tyre and wheel wholesale business which distributes its products to over 2,300 customers including tyre retailers, car dealers, mechanical repair businesses and automobile accessories retailers throughout Australia and New Zealand. By the Listing Date, National Tyre & Wheel will also have operations in South Africa.

It is anticipated that NTD will list on the ASX during December 2017.

http://www.ntaw.com.au

 

[Huskar]

This a fallen IPO, a category which is interesting because it suggests that the company was dressed up for the IPO and the sheen has come off, but there is likely to be a good business under the muck because that was the reason it could list in the first place... However, here not as compelling because rather than a PE-sell down it was a capital raise for new acquisition / expansions.

Getting squeezed by currency and by price rises from large supplier. I don't hold but one to look into further and given large price falls an interesting one to have on the radar. What do others think?

 

[Jackass]

Yep I hold this. Got in a little while ago during the covid panic selldown. The case for this one is fairly easy to understand - selling tyres in a country like Australia, NZ, and South Africa with poor public transport networks, poor rail freight networks and large distances to cover. Got them Cum div on a yield better than the the cost of capital and they were trading below book so took a punt. Then they go and take over a competitor at the right price and the share price takes off. So watching this one with interest.

 

[finicky]

Looks good for a dividend buy during a general market downer. Low risk 25c buy during Covid crisis in hindsight.
T4U acquisition at net asset value looks good opportunistic buy - though non hostile as merger has been discussed as complementary by both managements for a while before crisis.

 

[Jackass]

Ah hindsight - the only indicator I know of with a 100% accuracy strike rate. I can only wish that I had been good enough to catch the exact bottom. My entry was closer to 35c and was on the way down. Caused me to spend a bit of time looking at these and was happy with what I saw so held on. Have sold off a few on the recent price rise though. Not sure how safe that dividend yield is going to be in the near term as they will probably have to concentrate on paying down the debt used in the recent T4U buy. Still they look a good long term prospect so happy to hold.

 

[galumay]

Interesting little business, I had a look at this week. I like the fact that its a very simple to understand business in a pretty unloved and unwatched sector. I also like the tight registry and the skin in the game from Mr Smith.

Interestingly I might have bought if I had researched it prior to the acquisition, but the debt is now a killer for me. I will keep an eye on it though, if they can execute and pay down the debt quickly I may have another look - although given they have done it once I would be wary of future expansion of the debt.

 

[Klogg]

Interesting little business, I had a look at this week. I like the fact that its a very simple to understand business in a pretty unloved and unwatched sector. I also like the tight registry and the skin in the game from Mr Smith.

Interestingly I might have bought if I had researched it prior to the acquisition, but the debt is now a killer for me. I will keep an eye on it though, if they can execute and pay down the debt quickly I may have another look - although given they have done it once I would be wary of future expansion of the debt.

The debt isn't much of a concern, as it's backed by even more inventory that they purchased. Sure, inventory obsolescence is a risk, but one with minimal probability given they effectively bought out a business they understand thoroughly.

This is really a crappy business with excellent management. They're price takers, hold big amounts of inventory and subject to FX risk. But management execute very well, with so little fat in the business.

It's worth noting that the T4U business was very likely a forced sale. You'll note they sold in April, with the contract stating things were effective as of end of April even while conditions were not met. In the meantime, demand has basically gone V-shape post corona, with substantial increase in demand. ARB (June/July set records for their order book) and RPM (ove 50% increase in Bus/Truck tyres) both confirm this.

The other indicator is net cash, as reported throughout recent trading updates and aquisition notices. The below is taken from a post on another forum:

***
30/12/19:
Net cash 5.3 (17.7-12.4).
Paid out 750K (ITS) + 1.25m (dividend)=2m = 3.3m

27/5/20:
with cash on hand at 30 April of $18.4m(net cash of $6.0m) ie +2.7

30/6/20:
cash on hand at 30 June 2020 of $20.8m(net cash of $8.5m)ie +5.2

5/8/2020:
Immediately prior to the completion date,NTD had cash of $25.4m ?+9.8m (can't tell exactly)
***

They've effectively shown FCF of $9.8m for 2H20, after accounting for dividends and acquisitions. It's not the most precise measure, as inventory would now be a little lower given increasing demand, but it certainly shows strength in the business.


Given current run-rate for all businesses involved is $450m revenue, if they can squeeze a 7% EBITDA margin out of the entire group[*] (NTD already doing 8%), you've acquired $31m of EBITDA for an effective EV of ~$80m (assuming net debt of ~$30m post-acquisition).
D&A should come in about $4-5m, so EBIT would then be about $26m. Finance costs $2-3m, making PBT ~$23m. Assuming 30% tax, ~$16.1m PAT[**].

(Note, NTD already put cost cutting measures in place, becoming effective FY21. This will increase NTD margins coming into the increase in demand)

So my base case has me buying a business at about 20% above NTA (50cps purchase price), with a future expected profit of 14.2cps. It hardly seems demanding, and the downside is limited.

And whilst the debt level seems scary, their debt is on favourable rates, because it's backed by inventory. The lender seems to agree, given they extended credit during a pandemic.


Notes:
[*] T4U sells to larger customers with smaller margins, so I don't expect it to match NTDs future EBITDA margin. But it should improve significantly from the low of March/April.
[**] FX will also play with profits. May/June trading updates were with a higher AUDUSD. Reverting to previous levels (~60-65c) will impact the business.

 

[galumay]

Thanks Klogg, great detailed analysis there, very generous of you. I will have to have a deeper look, the debt level is way beyond my comfort zone and outside a hard rule in my metrics, but investing is a journey of learning and change!

 

[Klogg]

Thanks Klogg, great detailed analysis there, very generous of you. I will have to have a deeper look, the debt level is way beyond my comfort zone and outside a hard rule in my metrics, but investing is a journey of learning and change!

I looked at this a few times before I was comfortable. I wouldn't blame you for concluding otherwise.

And just on the point of management, check this out (from the FY19 report):

You could probably count on one hand the directors that have ever gifted employees something that sizeable - out of their own pocket!

 

[galumay]

Thanks Klogg, I did notice that reading the old reports - it jumped out at me for the same reason, I must have read thousands of AR's, HY's & other presentations and I have never ever seen management do anything like it! (and most of my holdings have management/founders with "skin in the game" though high %'s of the issued capital.)

 

[Jackass]

Hi Klogg, I agree with your figures broadly with one important exception. If you read the announcement regarding how the debt is structured that they used to fund this purchase, you will see that the overdraft facility $5m has to be repaid in the next year. Also the Term loan has a repayment of $2.5m every year. So my numbers have the estimated profit after tax next year at ~ $10.8m or approx 9.5c a share due to the $7.5m in debt repayments due in the next year. Slightly more conservative. Still I would love to be wrong on this and for you to be right.
As an aside I do like the way the lender is forcing these repayments on them. It forces large repayments at a low interest rate which should see the principal reduce quickly. One thing to watch out for, the conditions give NTD the right to increase the trade finance borrowings by an amount equal to term loan repayments - so I will be keeping a close eye the trade finance borrowings to see if that goes up.
Another thing to note. This one has caught the attention of the Pros, I see Forager hold 5.81% of this. They did hold over 7% but have sold some recently - I assume due to risk management. Same problem as what I had I guess. Due to the rapid price rise this became a larger portion of my portfolio than I was comfortable with so I took some money off the table. Happy to have those types of problems though.

 

[Klogg]

Hi Klogg, I agree with your figures broadly with one important exception. If you read the announcement regarding how the debt is structured that they used to fund this purchase, you will see that the overdraft facility $5m has to be repaid in the next year. Also the Term loan has a repayment of $2.5m every year. So my numbers have the estimated profit after tax next year at ~ $10.8m or approx 9.5c a share due to the $7.5m in debt repayments due in the next year. Slightly more conservative. Still I would love to be wrong on this and for you to be right.
As an aside I do like the way the lender is forcing these repayments on them. It forces large repayments at a low interest rate which should see the principal reduce quickly. One thing to watch out for, the conditions give NTD the right to increase the trade finance borrowings by an amount equal to term loan repayments - so I will be keeping a close eye the trade finance borrowings to see if that goes up.
Another thing to note. This one has caught the attention of the Pros, I see Forager hold 5.81% of this. They did hold over 7% but have sold some recently - I assume due to risk management. Same problem as what I had I guess. Due to the rapid price rise this became a larger portion of my portfolio than I was comfortable with so I took some money off the table. Happy to have those types of problems though.

How does debt repayment reduce NPAT?

 

[Klogg]

Hi Klogg, I agree with your figures broadly with one important exception. If you read the announcement regarding how the debt is structured that they used to fund this purchase, you will see that the overdraft facility $5m has to be repaid in the next year. Also the Term loan has a repayment of $2.5m every year. So my numbers have the estimated profit after tax next year at ~ $10.8m or approx 9.5c a share due to the $7.5m in debt repayments due in the next year. Slightly more conservative. Still I would love to be wrong on this and for you to be right.
As an aside I do like the way the lender is forcing these repayments on them. It forces large repayments at a low interest rate which should see the principal reduce quickly. One thing to watch out for, the conditions give NTD the right to increase the trade finance borrowings by an amount equal to term loan repayments - so I will be keeping a close eye the trade finance borrowings to see if that goes up.
Another thing to note. This one has caught the attention of the Pros, I see Forager hold 5.81% of this. They did hold over 7% but have sold some recently - I assume due to risk management. Same problem as what I had I guess. Due to the rapid price rise this became a larger portion of my portfolio than I was comfortable with so I took some money off the table. Happy to have those types of problems though.

Also note they have an unused $5.5m Equipment finance facility. Given they're basically buying inventory, as they turn it over, they can repay the $5m overdraft and draw from the finance facility.

Effectively, there should be a net $3m FCF requirement ($5.5m + $2.5m - $5m) to pay back debt principle amounts, plus any interest.

 

[Jackass]

Sorry, I'm an Engineer not an accountant. So I have not treated the debt repayments correctly from a strict accounting viewpoint. My broader point still stands though - I have been slightly more conservative in my assumptions than you. Guess we will have to wait and see who is right. I really hope you are and I have been conservative.

 

[Klogg]

So I have not treated the debt repayments correctly from a strict accounting viewpoint.

Principal debt repayments dont reduce profit by any accounting standard, regardless of how strict you want to be. Only interest owed has this effect.

Are you talking about cash flow instead?

 

[galumay]

It would be nice if debt repayments did reduce profit, then I could claim them as an expense at tax time!

I ended up taking a position in NTD after some more research & analysis, thanks again @Klogg for you generosity is sharing your thoughts on the business.

 

[Klogg]

It would be nice if debt repayments did reduce profit, then I could claim them as an expense at tax time!

I ended up taking a position in NTD after some more research & analysis, thanks again @Klogg for you generosity is sharing your thoughts on the business.

Good to hear, and glad my posts were helpful.

It's worth noting that many companies in this space are reporting consumer activity increasing (CAR, BAP, MNY). There are also links from early super release to increased car sales, which is concerning as this is a one-off.

Let's see government debt (Jobkeeper/seeker) has allowed the consumer to deleverage and start spending again.

 

[Jackass]

Sorry for the late reply on this. Day job got in the way.

Yes Klogg you are right, should have used the term cash flow, not profit. The larger point I was trying to make is that I don't think these are a safe buy as a dividend play. Making money should not be the problem - but an awful lot of the money they will make will have to go on the debt repayments.

Just a question on your point about the $5.5m unused equipment finance. Can they actually draw on that to meet the obligated yearly repayments? That equipment finance is for buying things like new vehicles, forklifts ect. Using it to meet debt repayments might breach the finance t & c 's? I would have thought that using it in that way would have been at the very least unethical.

On the larger question of is the consumer going to buy more or less tyres - wear on mechanical components is a subject where I do have a little bit of expertise. Tyres in general fail or need replacing based on usage. They wear at a set rate per Km of use. Most people understand this instinctively. What may surprise people is that only about 11% of mechanical components actually follow this model.

As an aside there are other factors that will affect the tyre wear - driving styles, maintenance practices ect. There is also the chance of something random happening - driving over a nail, car accident ect. However these probabilities are also based on the no of Kms driven. Once again comes with the caveat that this may apply more to certain people than others. There are also infant mortality failures on tyres, 2 main causes here are manufacturing defects and incorrect fitment. However with modern manufacturing QA / QC and the fact that most tyres are fitted by trained mechanics / tyre fitters infant mortality in tyres is pretty low. Now the part that I like about this business - the end consumption of their product is not discretionary by any means. A cop can and will slap a defect notice on your car for bald tyres. Scalies will put truckies off the road for the same reason. So what the ultimate driver of tyre consumption is going to be is average no of Km's driven per person, number of vehicles on the road and freight movements by road.

So as we emerge into a post covid world some trends that may affect NTD:

Switching effect for holidays - people taking road trips instead of flying overseas. Likely to be a factor as international travel does not look like coming back anytime soon.
Offsetting this is decrease in commuting as more people work from home.
Population growth / increase in migration. This is likely to be down for the next few years however will eventually come back. If a vaccine comes this will come back in a big way.
A little bit of the consumer splurging and upgrading from cheap tyres to higher quality products. As already noted by the increase in ARB order book. Government handouts help here as well.

 

[Klogg]

Just a question on your point about the $5.5m unused equipment finance. Can they actually draw on that to meet the obligated yearly repayments?

Not directly, but think about the nature of the business. They buy inventory, then sell/distribute it for a slightly higher price.

Everything they bought was covered by assets, most of which was inventory. When they sell some of those, they can put that money toward existing lines of credit.
Then, when they buy more inventory to replace the stuff that's sold, they buy it using the Equipment finance facility.

It's the same outcome, whilst using the facility as intended.

Offsetting this is decrease in commuting as more people work from home.

Not quite. We're now seeing people avoid public transport, in favour of driving. Purely to avoid close contact.

Second order effects aren't always what we think they are...

 

[Jackass]

Yes I understand that they buy the goods using their finance facilities and then sell / distribute for a profit. Without having access to the T & Cs of their finance, I would be surprised if they could use the equipment finance facility to buy inventory. Generally speaking equipment finance can only be used to by machinery and equipment needed for the operations of the business.

What you are referring to, the purchase of new inventory to replace inventory as it gets sold, should show up as drawings on the trade finance facility - of which they still have plenty unused. And maybe the contingent liability facility if they use letters of credit.

I can hear people now "FFS who cares if it shows up as equipment finance or trade finance drawings". Well it is a subtle distinction but an important one, as it gives clues where to look for leading indicators of the business not performing as well as expected. If we start seeing inventory go up and trade finance drawings go up with it - it indicates an inventory management problem.