Expanding on the exclusive contracts with Cooper Tire & Rubber Company, as it's the aspect of the business providing an economic moat. National Tyre and Wheel has had the right to import and distribute Cooper Tires since 1989, this agreement was made exclusive to NTD in 1998.
The agreement is bound for five years, autmatically renewed upon expiry unless terminated on the reasons below. The current contract expires in September 2022.
The contract can only be terminated if:
a) The parties mutually agree to its termination.
The probability of either party choosing to terminate the contract is almost nil, the agreement is mutually beneficial and has been in place for decades.
b) National Tyre and Wheel does not hit minimums for two consecutive years.
If this were to occur, Cooper must buy back all unsold product and advertising material. As inventory accounts for a significant portion of the balance sheet, this requirement lends strength to book value. It would simply be cheaper to buy NTD than create a distributor themselves.
The agreement is an invaluable asset to National Tyre and Wheel's operations. It's a risk that's greatly mitigated because of these points above and find it unlikely there will be any issues regarding the contracts in the future.
National Tyre and Wheel (NTD) is a tyre wholesaler operating in Australia, New Zealand and South Africa. These tires are imported and supplied to retail shops around these countries.
Typically, the tire industry is competitive, providing (essentially) a commodity with little pricing power. However, the interesting aspect of this business is their exclusive contracts with Cooper Tire & Rubber Company (also owns Mickey Thompson). The contracts are automatically renewed every 5 years, unless both parties mutually agree to termination 30 days prior to expiration, or NTD does not hit minimum performance for two consecutive years. These contracts have been in place for decades and are unlikely to be broken as they provide benefits for both parties. The great thing about the tire industry, even in a pandemic, is that people always need tires. Despite Cooper and Mickey Thompson products are focused on 4WD and SUV premium tires, NTD expects FY20 EBITDA to be ~$9M.
Management has decent inside ownership, with co-founder Terrence Smith owning 27% of the company. Senior Key Executive, Chris Hummer owns 4%. Overrall inside ownership is 40% with small institutional ownership at the moment.
In FY2019, the company made $3.3M in FCF, which will likely improve over the years. It wouldn't be a stretch for NTD to grow these at ~4%. Assuming the company reports the expected $9M EBITDA, an EV/EBITDA multiple would be 3.1x. $33M market cap is a net-net, though majority of current assets are in inventory. There is plenty of cash ($17M) on the balance sheet, with little debt ($12M).
Now, the business is clearly nothing special. Though, they have a fantastic competitive advantage over the rest of the industry due to these exclusive contracts and I believe the market will re-rate this company around $0.55 within the next 12 months. Whether NTD is acquired by a larger company in the automotive industry or they continue to grow through organic growth and acquisitions, the company has a solid upside with limited downside. There's also a comfortable dividend yield while you wait.
*Disclaimer* I own $NTD in my personal portfolio.
Ron Shamgar - Head of Australian Equities at TAMIM Asset Management on $NTD
"NTD is a tyre and wheel wholesaler in Australia, New Zealand, and South Africa. The group has exclusive rights to import and distribute Cooper and Mickey Thompson branded passenger, SUV and light truck tyres. We took a position in the company in May as we anticipate tyre demand to increase as car usage becomes a preferred method of transport. In addition to people being increasingly wary of being confined in close quarters with strangers, public transport while enforcing social distancing is simply not equipped to handle a full-scale return to work. NSW’s "No dot, no spot" system, for example, has reduced capacity drastically.
We are attracted to NTD’s undemanding valuation with a net cash position, asset backing of 48 cents per share (compared to the current share price of 35 cents), forecast cash EPS of 5 cents (PE multiple of 7x) and an estimated dividend yield of 10% grossed up for franking credits.
During May NTD reported better than expected trading conditions with EBITDA guidance of $9m, net cash of $6m and a reinstatement of their dividend policy. We expect NTD to capitalise on the current environment and look to acquire other tyre distributors to add scale and volume in the lower price point of the market. We value the company at about 50 cents."
National Tyre and Wheel & Tyres 4U
NTD has issued an announcement regarding the acquisition of T4U, a company which has import, distribute, and retail businesses in Australia and New Zealand. Specifically, the company focuses on truck & business tyres, industrial tyes (e.g. fork trucks), and agricultural tyres. The specialty further diversified NTD's product and brings significant scale.
With both combined FY20 results, the entity would sell 2.5M units (FY19: 980K) and $450M in revenue (FY19: $168M). NTD will operate 30 distribution centers across Australia, New Zealand, and South Africa.
The acquistion is massive, at least relative to NTD. The estimated book value of the assets is $52M. The payment for these assets is estimated $48.8M, NTD's market cap on the 17/07/2020 is $49M.
To pay for the acquisition, the company has proposed to issue 11.4M shares at 0.43 to raise cash and a new debt facility. The company will hold a decent debt position post acquisition. The purchase of T4U could be an opportunity to drastically improve the earning power of NTD.
Mr Les de Celis, T4U CEO said: "Some years ago, I met with Peter Ludemann and others from NTD to discuss the prospects of a merged T4U and NTD business. We were very enthusiastic back then about the benefits we could deliver to suppliers and customers with an abundance of complementary skills in our teams with no significant overlap of products or suppliers. Changes in the industry since then have only made the case for getting together more compelling and we are extremely excited to join force with NTD."
"Trading results for the Group in May and June have exceeded expectations with revenue higher and overhead expenses lower than recent forecasts. NTD now expects FY20 Operating EBITDA1 to be between $10.5m and $11.0m."
Following an updated guidance on the 27/05 stating expected EBITDA1 to be ~$9M.
Thoughts on the acquisition
The Tyres 4U acquisition has potential to generate significant earnings growth over the next few years. However, shareholders will be diluted in the short-term and debt will be used to fund the purchase. T4U has 1.5x NTD's revenues for the price of $49M (roughly NTD's MC), yet was unprofitable for FY20 supposedly due to low demand, bushfires, COVID etc.
The success of the acquisition will come down to managements execution of synergising the businesses and improving margins for T4U. IF T4U is capable of improving EBIT margins to 6%, this stock is dirt cheap and has plenty of upside. Unless there are serious issues with T4U, this is plausable. It's not a complicated business, synergies should be relatively simple, management has experience in the industry, NTD has been operating for ~30 years.
It'll be interesting to see the numbers and management thoughts on how this acquisition will benefit NTD for the future.