Inchcape boosted by Derco integration

When a company makes a material acquisition, there's a chance it can go very badly wrong. So, it is reassuring that the early evidence suggests that Inchcape’s (INCH) £1.3bn purchase of Latin American automotive distributor Derco could well be a transformative move for long-term growth at the auto dealer. The shares were marked up by 9 per cent on results day as investors responded to positive noises on the integration of the business, which Inchcape bought in January, and the synergies it is bringing to the combined company.

Management reaffirmed that it expects Derco to boost overall earnings per share by at least 15 per cent this year and by 20 per cent in 2024. Cost synergies of around £12mn are expected this year.

Derco, alongside organic revenue growth of 13 per cent, drove adjusted pre-tax profits up by 35 per cent to £249mn, while the operating margin nudged up 60 basis points to 5.8 per cent.

One result of the Derco purchase is that the distribution division now dominates the top line to an even greater extent, with the new business the reason behind the 192 per cent rise in Americas distribution revenue to £1.91bn. The company isn’t resting on its laurels in the segment – it made 11 distribution deals and acquisitions in the first half, with contracts signed with businesses including Subaru, Mercedes-Benz, and Geely.

Elsewhere in distribution, which posts significantly higher margins than its retail cousin, APAC revenue rose by 17 per cent and Europe and Africa revenue was up by a quarter. Retail revenue increased by a relatively muted 5 per cent to £1.2bn.

Free cash flow fell by a tenth to £202mn, however, as higher interest costs had their impact. The company's debt profile has changed due to the Derco purchase, although pro-forma leverage of 0.8 times doesn't look demanding. 

The board is now guiding for full-year results to come in at the top end of market consensus. And a consensus forward price/earnings rating of nine times, according to FactSet, is certainly appealing, being a 26 per cent discount to the five-year average.

Numis analysts argued that “with good visibility on strong earnings growth over the next few years (Asia, synergies and lower interest) and continuing health in contract momentum, we see Inchcape's shares well placed to continue delivering”.

But there are still sectoral headwinds which give us pause. While the supply environment is improving, the company warned that “demand remains weak in a number of markets” across Europe and order books and margins are expected to moderate on the continent. Hold.

Last IC View: Hold, 743p, 23 Mar 2023