Free 7-day Trial
All Articles and Columns »

Northgate Plc - Tag Along?

November 29, 2012 | About:
Gusto Duel

Gusto Duel

3 followers
Northgate Plc is a provider of flexible fleet rental, mainly commercial vehicles (vans) and mostly to businesses (in the UK and Spain). The company emerges from a difficult 2008/2009 period when it was forced to raise new equity and then to rationalize its operations.

Comparing April 2012 and April 2008:

  • Fleet size decreased by 44% (91,300 vehicles vs.131,350).
  • Rent revenues decreased by 15% (₤504m from ₤578m).
  • Vehicle disposal revenues increased by 3.4% (₤203 million from ₤196 million).
  • Free cash flow increased to ₤136 million from negative ₤1.1 million.
As of Nov. 25, 2012, the shares trade on the London Stock Exchange, symbol NTG, for approximately ₤2.6 each. The multiples are:

EV*/EBITDA**EV/FCFEBIT/EVP/E
x2.65x5.712.20%x8.8
* Net debt amounting to ₤418.5 million (₤385.3 excluding operating leases) and diluted shares as of April 2012 (136.31 million) have been considered for the calculation of market capitalization and EV.

** EBITDA (EBIT + Depreciation + Amortization), EBIT (operating profit after exceptional expenses) and FCF (operating cash flow, after vehicle sales and purchases less other investments) are calculated based on April 2012 results.


Northgate operates a profitable and strong cash flow-generating business and as the largest independent player in the UK and in Spain, could make an attractive acquisition for one of the majors. As a general trend the industry is consolidating, and it witnessed a wave of acquisitions during 2011.

Soon enough (with debt going down) the strong FCF generated by Northgate might entice private equity, too.

Also (with debt going down) at least the current difference between the enterprise value of ₤773 million and the market capitalization of approximately ₤350 million shall be recaptured by the share price which could (maybe in three years) orbit the ₤5.5 range. In the meantime the company may reinstate the tradition of paying sensible dividends. The first dividend since 2008 was declared in June this year at ₤0.03 per share.

The company faces various "outside" risks related to matters such as competition, residual values, health of the economy or exchange rates and risks which are more company specific such as the debt load or the covenants (among others). The rationality proven by this management team since they took the helm in 2009 (fiscal 2010) provides some comfort with regard to their ability to handle the risks, increase the profitability and produce lively operating cash flows.

Revenue growth seems to be another priority on the management's agenda. Nonetheless, the strengthening of the sales team (up 25%) and the recent recruitment of a new sales manager (UK) are actions still to be proven as bearing fruit for the company.

The Investment Thesis

1 - Northgate trades below private market value while it offers a sensible foothold in the UK and Spain – two countries in which some of the major players enjoy either glorious or (surprisingly) inglorious market positions (more details later in the document).

As a general trend the industry is undergoing a process of consolidation with some deals completed in 2011 (Avis/Avis Europe, Hertz/Donlen, Avis/Apex, Alphabet/ING Fleet, ARI/Fleet Support) or undergoing (Hertz/Dollar Thrifty).

It appears that there is a gap between the current trading multiples of Northgate and the multiples paid by CAR for Avis Europe or to be paid by HTZ for DTG.

- Avis (CAR) purchased Avis Europe at approximately 13 times earnings

- Hertz (HTZ) offered Dollar Thrifty (DTG) about 15.3 times earnings (2012 estimated earnings of DTG)

- DTG, CAR and HTZ trade at 13x, 14x and 19x P/E (source: Reuters)

A buyer of Northgate would acquire:

- Sensible enhancement of the UK and Spanish market positions. Northgate is the largest independent player in the UK and probably in Spain, too (details later in the document).

- A portfolio of more than 4,000 customers, a network of 62 locations in the UK, 23 in Spain

- An EBIT/EV yield of 9.8% (at an acquisition price of ₤4/share)

- A respectable stream of free cash flow FCF/EV yield of 14.1% (at ₤4 per share) and profits with room for improvement if, for instance, cost of debt is reduced from the current 7.1% achieved on average by NTG

- A little extra on the side – the ”Van Monster” retail sales network which operates eight locations in the UK and five in Spain

If those assets are as attractive as I think they are, especially given:

- The consolidation trend

- The inglorious market positions of some major players in UK and Spain

… then maybe Northgate is worth more than ₤2.6 per share and maybe a multiple of 3.5 to 4 times EBITDA (£600 million to £746 million equity value), meaning ₤4.5 to ₤5.5 per share would be closer to fair value and would provide a premium of 69% to 110% to the current market price.

Rumor: In October 2012 the Times printed that Avis might be offering to buy Northgate for ₤4 per share (a 54% premium to the current price). That would value the company at approximately £545 million market cap, or approximately 13.5 times earnings, or 3.31 times EV/EBITDA (as of April 2012).

2. - On a stand alone basis, equity value shall grow with debt reduction (scheduled bank repayments of £68 million or approximately 16% of total finance obligations are due as soon as November 2012), or better if fundamentals improve further:

The current enterprise value is about ₤773 million of which net debt plus leasing is ₤418.5 million. During 2008 to 2012 Northgate produced on average ₤115 million of free cash flow and ₤322 million of EBITDA:

_______________________

EBITDAFCF
£ m£ m
2012291136
201130995
2010306182
2009363163
2008340(1)
Average322115


* EBITDA = EBIT + Depreciation + Amortization + Impairment of intangible assets (2011,2009).

________________________

Exit at 29% IRR

Assuming that in three years time:

- Enterprise value of the company remains ₤773 million

- EBITDA is ₤291 million

- FCF is ₤136 million annually

- Outstanding shares will be 138.6 (versus 136.3 April 2012)

- And debt is fully paid back

Then the equity of Northgate would be valued around the rather not expensive multiples of:

- EBITDA multiple => 773/291 = 2.65 times

- FCF multiple => 773/136 = 5.68 times, FCF yield = 17.1%

- Price per share = ₤5.47

If the entry price per share is ₤2.6 the IRR is close to 29% (assuming no dividends are paid during the next three years).

Exit at 15% IRR

Maintaining the same assumptions as above, except enterprise value, which I have assumed now to be ₤552 million in three years’ time, then the resulting IRR of 15% is accompanied by:

- Equity value (no debt outstanding) = ₤552 million

- Price per share = ₤3.88

- EBITDA multiple = 1.9

- FCF multiple = 4.06 (FCF yield of 24.7%)

Not expensive multiples and still decent return.

The analysis below tries to evaluate the performance of the business and the risks.

Review of the Business

Following nine years of consecutive growth, Northgate’s fleet peaked at 131,350 vehicles in 2008 of which the UK had 68,600 and Spain had 62,750. The tide has turned, fostered by a radical drop in residual values (“Used car auction prices fell by ₤1,000 per unit in the second half of 2008,” according to BCA – European Used Car Market Report).

During summer 2009 (fiscal 2010) the company had to defer the testing of covenants, raise new equity (₤108 million) and agree to new lending facilities (£880 million, which became effective, upon the receipt of the equity raising proceeds). During fiscal 2010 the CFO who had joined in 2008 became CEO, a new chairman was appointed, as well as a new CEO and a new CFO in Spain. This management team (whose compensation is currently linked to ROCE and EPS, in 2011 CEO’s compensation was linked to ROCE and net debt levels) barred a strategy that promoted “market share first” and promoted a new one which could be summarized by a “leaner but fitter” slogan.

Deleveraging, positive free cash flow generation and the improvement of the bottom line (and ROCE) have been achieved via:

- The organizational restructuring of the company, by consolidation of 20 operating companies in the UK and two in Spain, accompanied by putting all the services under one brand, implementation of company-wide ERP and centralization of customer service

- The fleet size decreasing by 44% during 2008 to 2012 but the rental revenues decreasing only by 15%, with EBIT decreasing by 25% (but growing each year during 2010 to 2012 and getting close to the 2008 level if exceptional expenses lose recurrence) and FCF increasing to ₤136 million from negative ₤1.1 million

- Management of the assets that achieved 88% to 90% utilization of the vehicles (by selling excess vehicles and better management of the fleet). By comparison Dollar Thrifty, for instance, affirms vehicle utilization of 80% to 83%

- Obtaining a certain diversification away (mainly Spain) from customers operating in construction industry by increases in wholesale and retail distribution, and electrical, plumbing and equipment maintenance service sectors (in April 2012 the construction had a weight of 34% of vehicles on hire as compared to 37% in 2011 and 55% in 2010);

- Closing down some locations in both the UK and Spain;

- Reducing the number of personnel to 2,918 from 3,402 in 2009.

The turnaround is illustrated by the numbers below:

YearVehiclesRent RevenuesAverage annual rent per vehicleNet DebtFCFEBIT
pcs₤m₤/year/veh₤m₤m₤m
2012 91,300504 5,71038513694
2011 104,700537 5,5665299583
2010 109,800564 5,37461518271
2009 123,300610 5,320936163(118)
2008 131,350578 5,108894(1)118
2007 120,300526 5,058755(37)107
2006 111,000373 4,535524473


TREV = total revenues, rent revenues + revenues from disposal of used vehicles (for 2006, 2007 the income statement did not include them so I plugged in the amounts corresponding to sales of vehicles from the cash flow statement)

AARPV = average annual rent per vehicle, calculated by dividing rent revenues of the year by average fleet for the year ((beginning balance + closing balance)/2 x 0.9 to adjust for vehicle utilization)

FCF = free cash flow: operating cash flow (after vehicle sales and purchases) less other investments

WC = working capital (current assets less cash - current liabilities less short-term debt)


These good feats are accompanied by:

• Allowance for doubtful receivables still large at (₤20.4)m versus (₤22.2)m in April 2011 and (₤17.08)m in April 2010. Bad debt at (₤3.2)m versus (₤4.3)m in April 2011 and (₤10.3)m in April 2010. Net impairment of receivables at (₤4.9)m versus (₤5.46)m in April 2011 and (₤12.07)m in April 2010

• Dilutive potential of various performance schemes may go up to 10% (momentarily 2.3%) of the shares. The CEO is remunerated with ₤375,000 in basic salary plus ₤96,000 in pension but can make ₤1 million (including cash, deferred shares, performance shares bonuses) if certain performance targets are achieved. Starting 2013 the CFO is remunerated with ₤200,000 in basic salary plus ₤56,000 in pension but can make ₤520,000 if certain performance targets are achieved. Employees can participate in a share scheme where they receive one share free for one purchased.

• Higher administrative expenses ₤60.6 million (April 2012) versus ₤56.8 million (April 2011)

• Decrease of rental rates in Spain by 2% during April 2012 to September 2012

• Covenants could still turn sour if the business experiences temporary setbacks:

“- Interest cover at April 30, 2012, was 2.4x (2011: 2.1x) with EBIT headroom, all else being equal, of £17 million

- Minimum tangible net worth: Headroom at April 30, 2012, was £99 million (2011: £85 million).

- Loan to value at April 30, 2012, was 53% (2011: 63%) giving net debt headroom, all else being equal, of £132 million.

- Debt leverage cover at April 30, 2012, was 1.3x (2011: 1.7x) with EBITDA headroom, all else being equal, of £97 million” (AR 2012).

The company will pay down ₤68 million of debt in November 2012 which shall deliver a bit more headroom for these covenants. The fact they declared a small dividend (₤0.03 per share) in June 2012 must show some confidence (rather than lack of rationality)

• A reduction in the fleet size which may influence the bargaining position with car manufacturers

• The defined contribution pension scheme currently shows a small surplus but was negative during 2008 to 2009

Main Risks

Decline in Rental Prices


In the UK the British Vehicle Rental and Leasing Association (BVRLA) published a member directory 2013 which contains information (not very exact but still meaningful) with regard to the fleet sizes of its members as well as the market segments in which they operate.

UK

The table below presents the total fleet size for each player that operates more than 3,000 vehicles, and their manner of approaching the light commercial vehicles segment (vans up to 3.5 tones). Figure “1” (in the table's cells) means that they are active in that sub segment:

R = Rental

L = Leasing

FM = Fleet Management


RankFleet SizeRLFMCompanyOwner
1 590,000---MotabilityCharity
2 296,961-11LexLloyds
3 167,886-11ArvalBNP Paribas
4 135,720-1-LeaseplanVW & Friedrich von Metzler
5 112,616-11AlphabetBMW
6 66,645-11AldSociete Generale
7 60,000111BTBT Group, spin off 2002
8 57,973-1-DaimlerDaimler Group
9 55,00011-Arnold ClarkSir Arnold Clark
10 55,0001--EnterpriseEnterprise Holdings
11 52,900111NorthgateLSE: NTG
12 51,518-11HitachiHitachi Group
13 50,000-11Ifs.InchcapeInchcape Group (LSE: INCH)
14 49,900-11GEGE Capital
15 39,9371--EuropcarEurazeo (RF.PA or RF FP)
16 34,656-1-LeasedriveMBO/Lloyds Development Capital
17 20,239---Avis
18 24,42711-Peugeot
19 24,1441--Hertz
20 16,4701--Thrifty
21 15,000-11Fleet Log
22 14,965111Fraikin
23 13,243-1-Carillion
24 10,9511--Burnt-Tree
25 10,866---Ogilvie-Fleet
26 9,76211-DCH
27 8,915-11Grosvenor
28 7,16511-FHS
29 7,060-11Fleethire
30 7,000-11Pendragon
31 6,817111Translinc
32 6,4091--Budget
33 6,2871--Clm
34 6,115-11Jct
35 6,1001-1TVR
36 5,500-11Tuskerdirect
37 5,0001--Hiregate
38 4,9501--Shb
39 4,936-11TCH
40 3,587-11FG
41 3,0491--Sixt
Total 2,141,955192720
Total BVRLA 2,500,000


(The full table which shows the players’ presence in cars, heavy commercial vehicles and minibuses is available for download as an Excel file at: https://www.dropbox.com/s/3hfiz4s0q6ft5i5/Market%20Data.xls.)

There are about 500 members of BVRLA operating 2.5 million vehicles (which I assume to be the total market):

(i) - The top five players (fleet of more than 100,000) control 52% of the market and are owned by major multinationals (notwithstanding a telecom company and a charity). None of them seems interested in the R (rent) segment (where Northgate conducts substantially all of their business) but in the more secure long-term L (leasing) and FM (fleet management) segments. Should any of them (or a few) move towards the R segment, then a decline in the rental prices may follow. On the other hand, rather than distorting the market they may look around for acquisitions (or if one distorts the market by lower prices, others may defend through acquisitions) and Northgate qualifies as a target.

(ii) - The bottom 15 players in the table (fleets between 3,000 to 20,000 vehicles) plus 459 others (which operate fleets of less than 3,000 vehicles) control about 22% market share (by fleet size). This cohort shall pose a lesser threat since if they act towards lowering rental prices they might be hurt harder themselves.

(iii) - The middle segment consists of 20 companies which operate fleets larger than 20,000 vehicles but lower than 100,000. Northgate, topped by five players in this group, ranks 11th in the total table (notwithstanding the Spanish fleet) (but I am inclined to think that they actually belong higher — the BVRLA data on fleet sizes seems a bit outdated and larger than actual. Northgate for instance was listed with 75,771 vehicles, although they only have 52,900). Interestingly GE, Avis and Hertz rank lower than 14th position. All of the players larger than Northgate (other than Arthur Clarke which combines car trading with fleet activities) are owned by multinationals. Unless I am wrong, as a general rule multinational companies are less inclined to lower prices to gain market share (but rather grow through acquisitions). The logic presented above under (ii) stands for the players in this group which are smaller than Northgate.

According to Northgate’s annual reports the hire rate increase in 2012 was 4% (added to 4% increase in 2011), but some customers moved to smaller vehicles. So, due to the mix influence the average hire revenue per vehicle increased by only 3% in the UK. In the Interim Management Statement (September 2012) the management reveals that “Hire revenue per rented vehicle has remained stable since the beginning of the financial year.”

Conclusion UK: All in all the risk of decline in rental prices stands, but it is rather a “business as usual” risk than something imminent, posing a threat to Northgate specifically.

Spain

In June 2011, Fleet Europe (a good quality publication) provided an overview of the industry throughout Europe from which I harvested some data to construct the table below:

Fleets Spain (+ UK and Global, FYI)

VehiclesSpainUKGlobal
Leaseplan 85,875 134,718 1,293,000
Arval 80,019 84,558 667,000
Ald 57,125 59,710 848,000
Northgate* 38,400 52,900 91,300
ING** 29,613 49,766 240,000
RCI Banque 10,917 13,422 489,000
Peugeot 10,243 9,500 185,000
Alphabet 7,868 43,947 301,000
Athlon 4,700 - 212,300
Citroen 1,828 21,918 178,000
Sixt - 9,500 119,700
GE(Europe only) - - 245,000
Daimler 2,400,000
Total 326,588 479,939 7,269,300
Source: Fleet Europe, June 2011, No 54
* from the Annual Report 2012
** purchased by Alphabet in 2011


Northgate appears to be the fourth-largest player in Spain. I take this as a ballpark ranking, not a bullet proof one. Even if the table above misses some smaller players, Northgate seems to command 8.6% of total market by fleet-size. According to the Spanish Association of Car Renting (www.ae-renting.es), the vehicle renting market encompassed approximately 445,000 vehicles in October 2012 and its 23 members represent around 99% of it.

The arguments and conclusion for thr UK above shall stand for Spain, too. But the market is more difficult currently, and Northgate has already experienced a decline of 2% in rental prices during April 2012 to September 2012 (latest Interim Management Statement).

Withstand Decline in Used Vehicle Prices?

The Arval used car market index printed in no 58, page 14 (June 2012) of Fleet Europe shows that after experiencing a large decline in second half 2008 and first half 2009 the used car prices rebounded but they are still below the pre-crisis level. What happens next? I think that venturing an opinion on the matter is as simple as stating the future range for S&P 500. However, owing to the same no 58 of Fleet Europe’s marathon interview with the CEOs of (mostly) top European players we can learn their opinions on the big picture:

Question: What about the residual values?

CEOs’ answers:

Ald - quite uncertain, to be monitored closely, but no crisis expected

Arval- not expected to recover pre-crisis levels

Alphabet- seem to have stabilized since 2010

Athlon- the past two years showed that risk reward needs to be included in the leasing price

Daimler - stable with a trend to increase

Sixth- recovering but not to pre-crisis levels

FGA Capital- due to commercial policies on new vehicles RV could be under pressure (he must mean cheap new cars)

Business Lease- pressure on vehicles that are less fuel efficient

KBC Autolease- residual values stabilized

No 58 of Fleet Europe available here: http://en.calameo.com/read/00119162289f9102171de

So, except contrarian Daimler ("stable with a trend to increase") people seem cautions (rather than straight pessimistic). Predictions are difficult since the materiality lies with supply and demand (market prices).

Back to Northgate. The chairman and the CEO feels more of the same as above about 2008/2009 (dreadful) but refers to 2010 through 2012 as "strong used vehicle markets in both UK and Spain" (the annual reports NTG publishes include the number of vehicles sold and purchased, as well as the total values, and there are also the lines in the cash flow statements that state the amounts paid to purchase and dispose of vehicles, so more raw data is available for the investors’ analysis).

The chart below does not contradict them.



Source: http://www.british-car-auctions.co.uk/About-Us/Latest-News/7-November-2012---BCA-Commercial-Pulse/

In the annual report the company also states that “Higher margin retail and semi retail channels accounted for 19% (2011: 22%) of disposals.”

They did not say the precise percentage of the retail sales handled through the ”Van Monster” retail sales network (eight locations in the UK and five in Spain). The annul report did not say if "Van Monster" itself is profitable.

Conclusion - The risk of decline in used vehicle prices stands but it is rather a “business as usual” risk than something imminent, posing a threat to Northgate specifically. However, given the covenants and the fact that last time it had to raise equity the risk of decline in used vehicle prices is the most significant for Northgate. Further reducing debt (₤68 million scheduled in November 2012) might bring some release to the matter.

This link provides useful info with regard to average age and prices for LCV’s auctioned in the UK:

http://www.british-car-auctions.co.uk/About-Us/Latest-News/7-November-2012---BCA-Commercial-Pulse/

Liquidity in Used Car Markets

Liquidity (demand) in the used car markets depends on factors such as: used vehicle finance, car manufacturer programs and scrappage schemes (“introduced in many EU countries to kick start sales of new cars in badly depressed new car markets” source: European-Used-Car-Market-Report-2012). The quoted report provides more details to investors at this link: http://www.buckingham.ac.uk/wp-content/uploads/2010/11/pnc-European-Used-Car-Market-Report-2012.pdf, produced by the University of Buckingham Business School.

The report also provides the below data:

" Sales (in million vehicles)".....2000-2007.....2008-2010.....Growth rate

...........UK

...........new...................................2.2..........................2.0............-9%

...........used..................................7.0..........................6.5.............-7%



...........Spain

...........new...................................1.4...........................1.1.............-21%

...........used...................................1.6..........................1.5.........-6%

The differences between the new/used car markets are obvious and the notable facts are:

- The used car markets are more resilient to recession

- They are quite liquid in the UK

- But less liquid in Spain – which is still liquid enough though considering that:

- During 2008-2009, in lower volume markets than the average, Northgate has been able to dispose of close to 14,000 cars per year.

- During 2010-2011 the company disposed of more than 19,000 cars per year (1.2% of average trading volume of the entire market).

Also, Northgate’s ”Van Monster” retail sales network (eight locations in the UK and five in Spain) might be useful for adding to the liquidity of its “for sale” fleet.

Other Factors Affecting Prices and Liquidity:

Obsolescence


The company does not run a significant obsolescence risk since it operates a rather diversified portfolio:

- Vehicle mix consists of medium vans 41%, small vans 34%, large commercial vehicles 13%, cars 8%, buses and 4x4 and other specialist vehicles 4%.

- Fleet composition by make in 2012 was Ford 37%, Mercedes 20%, Volkswagen 16%, Peugeot 15%, Vauxhall 4% and Other 8%.

Fleet Age

The table below presents the average fleet age as presented by the annual reports.

________________________________

Year....................years old

________________________________

2012....................1.79

2011....................1.94

2010....................1.97

2009....................1.82

2008....................1.45

_________________________________

The company does not run a significant fleet-age risk since on average the vehicles are less than two years old, which compares with the 3.75-year average age of fleet and lease vans at auction in October 2012. This link provides useful info with regard to average age and prices for LCV’s auctioned in the UK:

http://www.british-car-auctions.co.uk/About-Us/Latest-News/7-November-2012---BCA-Commercial-Pulse/

According to Leasing Life: “The average used LCV price at auction in the UK hit £4,447 in October, up 5.2% month-on-month and 3.3% year-on-year, and just shy of the two-year high of £4,483 reached in January this year, according to the latest report by British Car Auctions. Although values were up in all sectors, ex-fleet and lease values hit a record high of £5,201, up 3.2% month-on-month and 1.7% year-on-year. Retained value against Manufacturer Recommended Price was up by a point on September to 32.6%. The October average age of fleet and lease vans at auction was 45.24 months; average mileage was 72,352, and sale against CAP Clean was 101.52%)." Source: http://www.vrl-financial-news.com/asset-finance/leasing-life/issues/ll-2012/ll-230-nov-2012/fleet-friday-jobs,-money-and.aspx

Maintenance Regime

The company claims to have “improved vehicle maintenance regime.” Improved IT capability and systems should allow greater visibility and planning of the company’s 53 workshops (April 2011).

Downsizing the Fleet Might Affect Discounts from Manufacturers

During 2009 to 2012, Northgate purchased on average 29,725 vehicles yearly, about 30% of each years’ fleet. The average purchase price was ₤10,774 per vehicle (value of vehicle purchases as stated in the cash flow statement/number of purchased cars).

Considering the mix (by make) of the fleet described above as a proxy for the purchasing patterns the company buys yearly close to 5,000 cars from three manufacturers (Mercedes, VW, Peugeot), close to 11,000 cars from one manufacturer and about 3,500 cars from a few other manufacturers. Northgate is not a “whale” like Leaseplan, GE, etc., but it fares better than more than 400 smaller companies in the UK while it is most probably the fourth-largest fleet operator in Spain. The fleet focusing on light commercial vehicles might provide a slightly higher relative weight than apparent at the first sight in manufacturers rankings of buyers of such vehicles.

As a matter of mapping the average purchase price of ₤10,774 per vehicle realized by NTG during the last five years compares to the following (current) retail prices:

starts from
_______________________________________
Ford Transit Connect 10,260
Ford Transit Van 17,995
Mercedes Vito 17,680
Mercedes Sprinter 20,620
VW Caddy 12,860
VW Transporter 16,960
VW Crafter 20,800


Source: websites of LCV manufacturers, November 2012

Unless the fleet size falls dramatically, which appears not to be the case anymore, odds are that Northgate will not be disrupted by suddenly decreasing discounts but will stay more or less in the range of its current “discount brackets,” probably faring better than a lot many smaller competitors and worse than the majors.

The Risk of Increased Cost of Debt

The current average cost of debt is 7.1%. If covenants are breached additional costs may occur. The company is embarked on a deleveraging program (next tranche of £68 million to be paid back in Nov 2012) which will contribute to mitigate this risk.

Risk of Irrational Management

This management team acted rationally during 2009 to 2012 and has recent memories of difficult times. Odds seem higher for ration to persist (no extravagant ideas like empire building for instance are signaled by the current “leaner but fitter” behavior).

Depreciation Policy

Depreciation can be (to a large extend) subjectively determined by management based on their estimates of residual values for vehicles to be disposed (the higher the estimates, the lower the depreciation, hence the more improvement to the bottom line, EPS, bonuses).

A comparison of the ratio between depreciation and rent revenues for Northgate (NTG) and a few other industry players is presented below:

Depreciation/Rent Revenues

% of rentalDate
CAR32%31.12.2011
DTG21%31.12.2011
HTZ22%31.12.2011
NTG38%30.04.2012
Lesedrive39%31.12.2011
Sixsth21%31.12.201


Northgate’s management seems more conservative than the SIxth, CAR and HTZ colleagues, but Sixth, HTZ and CAR have in place agreements requiring automobile manufacturers to repurchase used vehicles or guarantee their depreciation rate, so they are not directly comparable.

DTG has little such programs in places and trades the used vehicles on its own. They claim to keep vehicles in rental service for approximately 18 to 22 months which also compares better with Northgate’s latest average of 21.5 months. Northgate’s management is more conservative than DTG’s with a depreciation to rent ratio of 38.3% versus DTG 21.4%.

Leasedrive (“LDR” in the table above), the MBO backed by Lloyds Capital, makes its annual report public, and its depreciation to rent ratio is 38.6%.

For Northgate, depreciation expense (April 2012) represented 38.3% of rent revenue. This compares with 40.2% (April 2011) and 40.8% (April 2010) and 36.5% to 37.5% during 2006 to 2008). Given the "Strong used vehicle markets in both the UK and Spain," the decrease of 2.1% in depreciation between 2011 to 2012 does not look like manipulation to improve the bottom line but a “business as usual” type of adjustment.

Foreign Exchange Risk

Spain produces 35% of Northgate’s revenues and about 33% of the group’s EBIT in euros. In addition, 250 million of long term debt is denominated in U.S. dollars. The company uses cross-currency swaps but if the catastrophic scenario happens (euro related), then the turmoil may affect the covenants. This deserves a bit more investigation on your part.

A Review of the Growth Opportunities

Rent Revenues


There is little factual indication yet that rental revenues will grow unless the UK and Spain’s economies grow as well. The rental rates have been increased during 2011 and 2012. But this year the UK remained stable (April through September 2012) and in Spain rates have been decreased by 2% — still not an enticing environment. On the other hand, management seems to believe there are hopes for organic growth in the UK and acted towards it, given these public announcements:

  • Nov. 12, Jon Tobbell joins as the National Sales and Marketing Director. He apparently achieved 50% revenue increase in his former role at Hermes UK. He “hopes to achieve comparable results for Northgate” (Hermes UK is part of the European group Hermes Logistics Group approximately EUR 1.8 bn turnover last year, which is owned by German mail order and catalogue retail major Otto Group).
  • Northgate’s product addressed to the retail market (vans for personal use) was, at Oct. 31, 2012, on track to double (to £4.4 million) as compared to last year.
  • May, June 2012, company announces 25% increase in its sales force and promotion of new head of national sales (probably replaced in November 2012?).
  • New supply chain and business development director and new area sales manager northeast have been appointed.
We shall see if the organic growth hopes acted upon by the management through strengthening the team (as described above) will materialize.

The UK market is quite fragmented with +500 players. The top 41 players deliver about 2.14 million vehicles to the market while small fleets of less than 3,000 vehicles each provide at least 450,000 vehicles to the market. According to the latest management release the new sales team will focus on both national and regional level in order to increase penetration/market share and they seem to feel that Northgate might enjoy some competitive advantages as compared to its smaller competitors. What they say makes sense, the reality test will follow during the next 6 months.

Disposal Revenues

The company seems to be doing the right things (fleet mix, fleet age, maintenance) which is good. Materiality is with supply and demand so except offering proper vehicles, there is not much else they can do.

EBIT

Shall improve assuming that:

- The savings in staff costs resulting from the decrease in the number of personnel will be preserved. That represented an economy of ₤1.6 million (April 2012) versus April 2011. Given 25% increase in sales agents at least some of this economy will go away.

- The exceptional administrative expenses such as restructuring costs 2012 - £7 million, 2011 – £5.6illion, will disappear. The net impairment of receivables expensed in COGS was also eating out of EBIT £4.9 million in 2012, and £5.5 million in 2011.

Should these phenomena diminish in significance, as they are expected to, EBIT will grow even if revenues are stagnant or slightly decreasing.

Profit Before Tax

Interest costs are substantial currently. Paying back £68 million of U.S. loan notes (8.8% interest) in November 2012 will lower the interest expense by £5.9 million for next year. If all of the above mentioned expenses disappear PBT could grow by £19.4 million.

There are also some exceptional financial expenses which amounted to £3 million at April 2012 (versus £4.2 million in 2011, £15.2 million in 2010 and £33.8 million in 2009) and last year included mainly extinguishment of debt fees and termination of swaps related expenses. These kind of expenses will most probably be recurring, but hopefully they will continue to diminish.

Net Profit

Grows with the above, but regular taxes will start to be paid, too, in 2013. A deferred tax asset which amounted to £17.2 million in 2009 has already been consumed to a large extend.

A Review of Nortgate's Ranking Within the Industry

Northgate is the largest independent fleet rental company in the UK although in appearance, Arnold Clark is larger (BVRLA table). Arnold Clark is mainly a dealer of vehicles which achieved £2.2 billion turnover in December 2010. Of this turnover only £155 million (and pretax profit £8 million) was generated by their vehicle management and daily rental business.

The next large independent (about 35,000 vehicles in the UK) is Leasedrive, the MBO backed by Lloyds Capital, which generated £104 million in turnover and £4.87 million EBIT in 2011.

As such, Northgate is the largest independent in the UK. It operates a profitable and sizable business in Spain, too. These feats make it more attractive than its competitors as an acquisition target for a strategic player interested in buying scale (market share, cash and profits).

GE, Avis and Hertz are each smaller than Northgate in the UK (and much smaller than the European majors) and probably in Spain, too.

Soon enough (with debt going down) the strong FCF generated by the company may also entice the interest of private equity firms.

Catalysts

- Acquisition by major player/private equity

- Faster deleveraging

- Debt refinancing at lower interest rates

- Dividend payment

Further reading:

http://www.northgateplc.com/northgate/irindex.jsp?n=3

http://expectingvalue.com/shares/northgate-ntg

http://quinzedix.blogspot.ro/2012/11/northgate-plc-vehicle-rentals.html

http://www.iii.co.uk/news-opinion/richard-beddard/white-van-stock-make-comeback

Disclosure: long NTG

Rating: 3.1/5 (15 votes)

Comments

batbeer2
Batbeer2 premium member - 1 year ago
Hi Gusto Duel,

Thanks for an interesting idea.

Question: Does the company disclose the current composition of the fleet?

Net PP&E stands at 800m or so - about the same as Enterprise Value. It seems to me investors are buying some 90,000 vans at roughly 8,900 apiece. This seems reasonable to me to me but not absurdly cheap (unless they are all MB or VW).

With the fleet shrinking, they have been selling old vans faster than they are buying new ones. I find it fascinating that they are collecting 160m in cash from the sale of (my rough estimate) 40 000 vehicles per annum. That works out to 4.000 per vehicle sold. I should hope those are old Vauxhalls they're selling and not Sprinters. I may be wrong on these numbers; correct me if I am.

- EDIT - Silly me, I just saw you mentioned it: Fleet composition by make in 2012 was Ford 37%, Mercedes 20%, Volkswagen 16%, Peugeot 15%, Vauxhall 4% and Other 8%.

With that I would add a couple of catalysts to your thesis.

1) They may be getting rid of inferior old vans and hanging on to the better ones. This should be good for maintenance expense going forward.

2) At some point, they will start getting better prices for their used vans simply because the average van in the current fleet is worth more than the vans they had before.


It may be worthwhile to check out the mix in recent years.
gusto.duel
Gusto.duel - 1 year ago
Hi Batbeer,

I thought that their fleet is not that old age (My car is 19 years old... but it was not the yardstick (-:).

See below the data from British Auctions_[www.british-car-auctions.co.uk].

They also have good brands in their fleet.

Fleet/LeaseAvg AgeAvg MileageAvg ValueSale vs CAP
Oct 201144.2771,021£5,111103.62%
Oct 201245.2472,352£5,201101.52%


I look forward to see how much of the debt was paid back during April - Nov. 2012. It comes out in a few days.
batbeer2
Batbeer2 premium member - 1 year ago
LOL, I drive a car that was built 1987...

On average the fleet is young, yes. The point I was trying to make is that the value of the current fleet depends both on age as well as brand. (MB is worth more than Vauxhall).

If there has been a shift in the mix in recent years that could hide some of the value in the current fleet.

I would exepect this to be the case based on the lowish price per vehicle sold in recent years. I'll look it up myself after I'm done with my next article.

gusto.duel
Gusto.duel - 1 year ago
I see what you mean.
gusto.duel
Gusto.duel - 1 year ago
The company reported half year results.

Negative:

- rent revenues down by £61m;

- average hire revenue per rented vehicle has decreased by 1% since the beginning of the financial year.



Positive:


- Debt decreased by £110m (on 20 November 2012);

- improved bad debt levels (Spain) - charge in the period of €0.2m, compared to a charge of €2.7m in the same period last year;

- improved DOS days (Spain) to 66 days from 72 previously

- Interest costs lowered by £3.1m as a result of lower average net debt;

- tangible net asset value of 273.6p per share (April 2012 - 264.9p per share).

The key challenge remains stabilization and growth of rent revenues. They have done a good job on costs with operating profit decreasing by only £8.4m despite rent revenues down by £61m.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK
Hide