Sandstone Insights: Bapcor faces leadership vacuum and earnings challenges

This article was written by Sandstone Insights on 6 May, 2024.

Suggestion: hold

Need to know

• Management and Board changes needed.
• Strategy reset required.
• Earnings recovery delayed until these changes are made.

A combination of management and board uncertainty, together with a weak earnings outlook, are conditions that would justify a Sell recommendation. Countering that is the large share price correction that has already occurred. We lean towards the prospect that both issues can be turned around to reinvigorate what is otherwise a decent business.

Interim leadership and board vacancies

With an interim CEO and a retiring chairperson, Bapcor (ASX:BAP) is lacking leadership at a time when it is facing a difficult earnings outlook. The sudden and unexpected withdrawal of Paul Dumbrell as the new CEO has left Mark Bernhard in place as the Interim CEO until a permanent replacement can be found. Chair Margie Heseltine is due to retire at the Annual Meeting in September, with a successor yet to be named.

This is an unhelpful state of corporate affairs at Bapcor that will not be rectified until suitable replacements can be found. The company must take extraordinary care that the process is conducted swiftly but effectively.

Strategic review and cost-saving initiatives

We would expect a new CEO to immediately review the key strategy, which is the ‘Better Than Before’ cost-saving initiative. We already expect the touted net $100 million EBIT benefits of this program to fall well short of the target and it may take longer to achieve whatever benefits are available. We now expect none of the guided $7-$10 million 2H24 benefits to be achieved, although these are arguably just delayed until FY25 and beyond.

Challenging trading environment and interest costs

The current trading environment is clearly weak, particularly in retail, so we expect Bapcor will try to mitigate this as a priority. At the group level, lower sales, reduced gross margins, and fewer cost savings are now being exacerbated by higher interest costs. An earnings recovery timeframe could conceivably be delayed until FY26.

Competitive pressure and revised earnings outlook

Bapcor pointed to the competitive pricing pressure in the Wholesale business. This is resulting in volume and margin compression. Bapcor will need to address this quickly to avoid losing market share. Bapcor revised its FY24 net profit guidance to $93-$97 million, which has forced consensus downgrades not only to FY24 but also to the next two years.

Investment view

On reviewing Bapcor's guidance and management situation, we retain our Hold recommendation as the share price has adjusted to the new guidance.

We expect a new permanent CEO appointee will want to review the company’s strategy. Given the Board had endorsed the ‘Better Than Before’ program, we anticipate this will come under close scrutiny and face a substantial revision to both the scale and likely timing of benefits.

The next information update is likely to be the August FY24 results announcement, leaving the market to either be patient or to find an alternative investment. Together with the CEO replacement process, this leaves the company vulnerable to uncertainty.

Bapcor is fixable and is a fundamentally good business that has temporarily misfired. The issues of senior management, a shift in the Board composition, and a redefined strategy must be answered before shareholders can be confident of a recovery. All of these will take time.

The share price is now at least 1 standard deviation below its 10-year PE ratio average.

Risks to investment view

Consumer spending could recover more quickly than anticipated, leading to improved earnings sooner than expected. This could occur despite Bapcor's management and Board uncertainty. A revised strategy could gain traction sooner than expected. Conversely, Bapcor could fail to resolve its problems quickly, which could result in further market share loss and further earnings deterioration.

Buy, hold or sell?

We have retained our Hold suggestion.

Chart 1: BAPCOR PE ratio is 1SD below its 10-year average

_{The information provided by Sandstone Insights does not constitute investment advice and does not have regard to the specific needs of any person who may receive it. No warranty is given as to the accuracy or completeness of the information and any person acting on it does so entirely at their own risk.}