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Inchcape PLC – Zeus Capital view on it’s Strategic Acquisition

Following the acquisition made by Inchcape PLC (LON:INCH) on 22 December, we have upgraded our forecasts accordingly increasing our 2017 and 2018 EPS numbers by 7%. Our forecast assumptions remain at the low end of the consensus range, largely due to our cautious assumptions for the UK market in 2017 and 2018. However, we the acquisition is a good fit, with UK EBIT expected to fall to just 12% of Group EBIT vs. >20% historically. The valuation looks undemanding in the context of the wider UK retail sector, and we estimate the balance sheet should provide a further £400m of financial firepower post its latest transaction. We therefore believe the long term growth potential of this business remains firmly intact.

Acquisition: Inchcape announced the acquisition of a significant proportion of Indumotora on 22 December, a South American family owned business that was established in 1922. This is a distribution business focused on Subaru (55% of 2016 vehicle units) and Hino (28%). We think this is a good fit given its existing presence in South America (Chile 49% of revenue, Colombia 34%, Peru 14% and Argentina 3%), and this acquisition will also provide a presence in Columbia and Argentina for the first time. We think it’s a good move to deploy its capital into distribution rather than retail give the underlying cash generation inherent in such businesses and relatively lower levels of capital intensity.

Financials: Inchcape paid a headline EBITDA multiple of 8.6x 2016 for this business, which is pre-synergy with long term structural growth expected in these markets as the new automotive consumers emerge as the middle class expands. The key difference with this transaction vs. others undertaken in the past by Inchcape is that there should be pent up demand from weakness in recent years in these markets reflecting a stabilizing/improving commodity price environment. On a pro-forma basis, we estimate this will add c10% to its distribution profits with underlying margins in this business running at 8% vs. 9% at Group distribution level albeit with Emerging Markets distribution margins running at 11%. We therefore believe this is scope for Inchcape to improve the performance of this business over time.

Impact on forecasts: We anticipate this transaction being 7% EPS enhancing in 2017 and 2018 under assumptions with no material synergy gains factored into our forecasts. This equates to a post-tax ROI 8% in 2017 rising to 10% in 2018. Management has stated that it would expect this transaction to exceed its regional WACC of >10% by year 3, which would imply underlying EBIT in excess of £40m vs. £25m delivered in 2016 highlighting the growth potential. Our forecasts remain at the low end of the consensus range as we took a cautious view on the UK motor retail sector in November.

Investment view: Following on from this transaction, we now estimate Inchcape PLC will generate just 12% of Group EBIT from UK Retail vs. 21% in 2012. From a valuation perspective, this therefore puts greater distance from Inchcape to the UK motor retailers. The Inchcape valuation looks undemanding in the context of the wider UK retail sector and the balance sheet remains very strong with a further £400m of potential firepower on acquisitions based on our calculations. We anticipate FY results from Inchcape on 1 March, and should gain clarity on its share buyback programme.