Description

Mkt Cap: NZ$ 44.35m (USD$29.2m)

Turners Auctions (TUA) is a cheap New Zealand micro-cap trading at 9x LTM earnings with an 8.3% dividend yield, a 14% FCF yield on, no debt, an activist 20% shareholder, and a commanding market position in car auctions. The auto business is cyclical and is affected by factors such as the state of the New Zealand economy and f/x rates (since NZ imports all its cars). Even in the midst of an economic downturn and difficult times in the auto business, which has reduced earnings and cash flow significantly from peak levels two years ago, TUA maintains an ROE of 21%, an ROTC of 45%, and throws of ample free cash flow. Today’s valuation is 3.5x EBITDA or 3x peak EBITDA. Cheap at trough earnings, TUA’s strong cash flow will recover beyond prior peak levels when the New Zealand economy and used auto market rebound.

Description:

Turners Auctions is the leading used auto auctioneer and the largest single seller of motor vehicles in New Zealand.  TUA sells about 150,000 used and damaged vehicles (cars, trucks, light commercial vehicles) a year, about 7% of total cars registered in New Zealand. The average car age in New Zealand is 11.9 years with cars under 2 years old representing less than 6% of total cars registered.  Sale of domestic used cars and imported used cars dominate total car sales (total new car sales are only about 3% of total registered cars per year). 

Turner’s seller base is 50% dealers (dealers selling used cars that were traded in or imported), 15% private (individuals selling to individuals), 30% corporate (sales of rental and other corporate car fleets) with the remainder from government and Turners own imported fleet of used cars. The buyer base consists of about 50% dealers (planning to resell cars to buyers from their lots), and 45% private (individuals). 

The used car auction business generates high cash flow and requires minimal capital investment.  TUA leases the property where auctions are held and the only inventory on its books is from its fleet import business (only 6% of total sales).  The majority of profit comes from commissions on sales which average about NZ$271 per car.

Competitive Advantage

• TUA has no major competitors.  Most auction companies are small, regional operations that don’t have the scale or selection of Turners.   
• TUA’s large seller base allows it to offer New Zealand’s largest and most comprehensive selection of cars, providing far greater choice to buyers than any car dealership. 
• Numerous sellers combined with TUA's own proprietary import and certified car business allows TUA to avoid pricing pressure from one dominant seller.
• Turners Auction Live, an interactive website where customers can watch live auction and participate in the bidding, expands TUA’s potential customers base beyond those physically present at the auction. 

New Zealand Economy

The weak New Zealand dollar has impacted sales of both domestic and imported used car sales in the last year.  Imports from Japan have fallen by over 20% and the overall used car sales market has been cyclically depressed. 

As an auction company, Turners acts as the transaction broker and, unlike dealers, does not invest capital in inventory.  With a declining NZ dollar, dealers are finding it increasingly expensive to import cars while sales prices remain flat to down.  TUA’s fleet business only accounts for 6% of its total car sales, and carries a month and a half worth of inventory.  In this tough market TUA has the flexibility to scale back its fleet business and isn’t forced to take on inventory risk. When dealers import and sell fewer cars TUA’s total commissions are impacted, however TUA continues to make a commission based on just the sale price of each car sold.  

TUA is still paying an 8.3% dividend yield and has a FCF yield of 14% in this difficult market.  The variable cost and low asset model allows TUA to adjust to the temporary downturn in volume sales.  As the 800 pound gorilla in the space (with 80% auction sales market share) TUA still is best position to survive the downturn. 

Finance Opportunity

On average approximately 50% of cars purchased from dealers in New Zealand are financed. TUA has historically not been in the finance business at all, and only launched a financing business in 2004. In FY 2005 approximately 5% of financed cars purchased at TUA were financed through the new finance division, which is still very low penetration. On just 5% penetration the finance division contributed $0.56m in pretax income, which was 7.4% of TUA’s total pretax income for the year. The finance division offers a substantial growth opportunity, especially since finance sales are done mainly on commission and will allow growth without incurring additional capital investment.   

At its 2004 peak, TUA produced free cash flow of NZ$7.8m, 28% higher than current free cash flow, with an ROE of 32%. And that was with no finance business. TUA will return to this level in the next 2-3 years with little additional capital investment and a minimal increase in operating costs as the economy recovers.  An economic recovery, increased used car auction volume arising from population growth, and growth of the Turners Finance business will allow TUA’s cash flow to surpass its previous peak.

Turners recently sold its unprofitable North America operations. These two sites have been a substantial drain on cash flow and were in markets dissimilar to the core New Zealand market. 

Valuation

Turners is a similar business to Adesa (KAR) posted on VIC a month ago, only TUA is the dominant market player (80% vs.18% market share), has net cash on the balance sheet versus KAR’s net debt, and is trading significantly cheaper. KAR was trading at 7.8x 2008 estimates EBITDA – capex while TUA is trading at 4.2x LTM EBITDA – capex, or 3.5x peak EBITDA – capex.  When looking at TUA’s EV, it is necessary to break out the finance ledger from the operating business. TUA had NZ$6.6m of discretionary cash and no long term debt on the balance sheet after separating the finance business, making the EV NZ$37.7m.

When the New Zealand economy is robust and the auto business is in full swing, TUA is seen as a growth stock and accorded a much fancier valuation, on higher earnings and dividend numbers. The stock reached a peak in June, 2004 of NZ$5.30/share, which is 315% higher than today. As stated above, peak earnings should be surpassed in the next cycle due to the financing business’ contribution.

For example, growth of the lending conversion rate from 5% to 10% (already increased to 5.6% in 1H 06) will provide additional $0.56m pre tax earnings a year. This would increase current earnings before tax 7% with no change in the core auction business.  

Management has a solid command of the business and is acting in shareholder’s interest, as evidenced by closing the North American operations and maintaining the dividend through the cycle. The three largest holders control just over 50% of the shares outstanding. Guinness Peat Group, with a 20% stake, is an activist investor and will work hard to realize value from the investment over time. None of the large holders has a strategic interest in the business.

Catalyst