Why we like this misunderstood ASX retailer
Most of Bapcor’s earnings aren’t exposed to slowing discretionary spending.
James Gruber: Hi, Angus. For those that don't know, can you outline what Bapcor does?
Angus Hewitt: That's as good a place to start as any. So, Bapcor, in short, sells spare parts and accessories for cars and trucks in Australia and New Zealand. There's three businesses, retail, trade and specialist wholesale. Retail is the most visible part of the business for most people. It's through brands like Autobarn, where they sell parts for the DIY consumer. They're probably the number three player here behind Supercheap Auto and Repco. The trade business, which is a business we really like, operates under the Burson brand, and this is where they distribute parts and accessories to independent mechanics. And the specialist wholesale business sort of feeds into those two channels.
Gruber: So, what's the breakdown in terms of revenues with those different parts, just to give us some idea?
Hewitt: About 20% of earnings are from the retail channel, maybe 40% from trade and 40% from specialist wholesale in rough numbers.
Gruber: The shares haven't done particularly well over the past few years. Why is that?
Hewitt: There's a few things happening here. So really, we have to take you back to late 2021, when the departure of their prior CEO, Darryl Abotomey, he's been at the helm for about a decade. He saw them through their 2014 IPO, and shareholders saw some really strong returns from Bapcor over that time. The details on his departure are fairly scant. It was originally penned as a mutual agreement, but there was deterioration in the relationship. It was certainly acrimonious. And we think the market has lost a bit of faith in management and they're yet to regain faith in new management it seems. More recently, in October last year, there was a trading update that said the slowdown in discretionary spending is weighing on that retail business, the Autobarn business, and shares took a bit of a tumble on the back of that. And then the third is a much longer-term threat, which is the threat of electric vehicles. The threat here is twofold. On one side, EVs require less maintenance. And on the other side, Bapcor currently distributes negligible EV-specific parts. And these are the things that are really weighing on the stock at the moment.
Gruber: Do you think a number of those issues are behind them or are they going to linger?
Hewitt: Well, we'll start with the management question. We think the business itself hasn't changed materially from where they were prior to the previous CEO departing. And more importantly, their competitive position hasn't changed. Bapcor can distribute a wider range of parts more quickly and at a lower cost than its competitors, which is where its narrow economic moat comes from.
On the discretionary spending slowdown, we think that really overlooks the resilience of the core business. So, like I said before, retail is about 20% of earnings. About half of that is what we would call discretionary, things like fluffy dice. And about half of that is what we'd call maintenance related, which is things like oil filters. The maintenance side of this equation is obviously much more resilient. The trade business and the specialist wholesale business for that matter are both almost wholly maintenance related. So, we've got 90% of earnings, much more defensive and 10% is exposed to that more discretionary side of things. Maintenance can be delayed to some extent, but it can't be foregone completely. And really, demand for automotive spare parts is driven by the increasing pool of vehicles in Australia.
And then the third part of the equation is EVs. So, this is a much longer-term threat, and it's probably longer term than most people think. Yes, the proliferation of new car sales that are electric vehicles is increasing rapidly. They were maybe 3.5% in 2022. They were about 7% last year. The proportion of EVs over five years old is let's round it to 0%. Over the next decade, even assuming a quick acceleration of EV penetration to 100% of new car sales by 2035, you've still got at least the next decade EVs that are older than five years old, being a low or at least a single digit proportion of the cars on Australian roads. And I know that was sort of a fairly complicated way of saying it, but what I'm really trying to say is Bapcor's target market is going to remain overwhelmingly internal combustion cars for at least the next decade.
Now, beyond that is where it becomes a little bit more complex, which is why we award Bapcor a narrow economic moat and not a wide economic moat because of how they deal with this transition. We think they're in a really good position by virtue of their distribution channel to be able to participate in this transition with their mechanic customers. About 10% of independent mechanics are EV ready. Another 40% are actively investing in infrastructure and equipment and training to be able to get EV ready. So, there is that to come, but at the moment, they obviously don't have any EV specific.
Gruber: How do you see valuations at the current price?
Hewitt: At current prices Bapcor looks really cheap. Profitability is improving and there's been a bit of volatility over COVID and we're starting to see that normalize. So, we had government stimulus really ramping up, discretionary spending, we're seeing that coming off now, which is weighing on the retail business and we're also seeing a bit of a cost cutting program that's going to cut out some of the duplicated costs and a bit of optimization. If you compare Bapcor with some of its U.S. counterparts, a lot of the difference in EBIT margin can be explained just by gross margin. We think there's upside there.
Gruber: What are the risks to your positive view on stock?
Hewitt: The EV transition is going to be really interesting. So, once we see a material proportion of EVs actually going beyond that five-year barrier, how much extra maintenance is required? We see that in the first five years, it's substantially less because EVs have much fewer moving parts, but beyond that five years, it still remains to be seen. The battery replacement is a big part of it. How many of these people were going to the manufacturer beyond five years versus independent mechanics and how Bapcor participates in that transition is really going to prove key.