There doesn’t seem to be much wrong with the Inchcape (LSE: INCH) business but the FTSE 250 stock has been punished by the market lately.
The international automotive distributor’s share price is near 665p, meaning it’s down around 28% since January 2023.
Despite the stock’s weak performance, the company’s earnings have been trending higher. And on 26 October 2023, the company reported robust third-quarter results.
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Strong recent business performance
Chief executive Duncan Tait said performance was strong in all operational geographies.
Looking ahead, Tait thinks the highly cash-generative and capital-light characteristics of the business will help keep the positive momentum going in the coming years. And Inchcape’s strategy aims to continue consolidating a “highly fragmented” market through growth and acquisitions.
City analysts expect earnings to increase by about 21% in 2023. And they anticipate a further advance of around 10% in 2024. Meanwhile, the directors “remain confident” about the medium- to long-term outlook for the business.
Those figures and expectations look pretty strong, to me. So, it’s a bit of a surprise to see what seems like a low valuation.
The forward-looking earnings multiple for 2024 is just over seven. And the anticipated dividend yield is about 5.6%.
Those indicators make the company look too cheap. However, it’s worth considering the balance sheet. Net debt is near £1bn. And that compares to a market capitalisation of around £2.7bn.
I’d consider the company as being on a multiple closer to 10 than seven when factoring in the debt load.
Acquisitive businesses often carry some debt and that situation introduces risk for shareholders. It’s worth keeping an eye on borrowings to make sure they don’t start to get out of control.
But for now, the interest cover from earnings is running just above five. And that’s okay as long as profits and cash flows hold up in the future.
Cyclical sensitivity
However, the multi-year financial and trading record shows the business has cyclical vulnerabilities. Inchcape was one of those firms that suffered when the pandemic hit. And its earnings plunged, as we might expect.
The directors reduced the dividends back then, but they’ve come storming back since. Nevertheless, fears of general economic weakness ahead could be one of the factors weighing on the share price and the valuation now. And a worldwide downturn is indeed another risk that investors must face up to with Inchcape shares.
However, I see the positive third-quarter update as encouraging. And the valuation is attractive.
My data provider shows that all the City analysts commenting on the company have the stock marked as either a ‘buy’ or a ‘strong buy’. And, on balance, I agree and think Inchcape is worth investors’ further research time now. Perhaps the shares could make a worthwhile addition to a long-term diversified portfolio.
