We remain comfortable with the distribution-led story at Inchcape Plc (LON:INCH), which now represent >90% of group profits. We have trimmed our forecasts to reflect the strength of the Japanese Yen and IFRS 16 as flagged in the guidance, which equates to a c5% reduction in 2019E and 2020E EPS. We also introduce of 20201E forecast for the first time, which we believe are cautiously struck, and below that delivered in 2017A. This also excludes the potential for further M&A activity, which to date has been successfully executed.
2018 results: The group has successfully absorbed weakness in parts of retail, through cost rationalisation within the segment and successful growth of the distribution business. The group delivered a ROCE (pre-tax) of 28% during the year, with a free cash flow conversion rate of 73%, highlighting the strength of the business model. This is driving the group’s effective capital allocation policy continuing to deliver solid value for shareholders, in our view.
Key performance drivers: Distribution continues to be a key driver of growth, increasing its share of the underling operating profit to 93% of group total. The Distribution delivered 6.6% revenue growth on a constant currency basis and was 3.0% excluding the Central America acquisition, which has integrated well. Margins did slip by 20bps YOY with margins in Asia up 90bps albeit offset by weakness in Ethiopia. Trading profit in Retail declined by 58.7% YOY with margins down 100bps to 0.6% and driven by the UK and Australia. Inchcape has also won two further distribution contracts with BMW in Kenya and Lithuania.
Forecast assumptions: We update our forecasts to reflect the impact of IFRS 16, FX impact on key markets such as Australia. We now expect adj. PBT in 2019E of £310.3m (vs. £326.3m previously) growing to £325.1m in 2020E (vs £342.3m previously). We also introduce of 20201E forecast for the first time, building in a £13.9m uplift YOY implying adj. PBT of £339.0m.
Outlook: The group continue to expect a robust performance across the Group in 2019 excluding the transactional Yen headwind previously flagged. Distribution is expected to remain robust in Asia, Emerging Markets and Australasia, with South American growth offsetting Ethiopian supply constraints. Strong growth in Europe is led by Greece and Baltics. In Retail, strong growth in Russia is expected to continue with the UK and Australia expected to stabilise from here.
Investment view: Inchcape trades on a 2019E P/E of 10.2x falling to 9.4x in 2020E, which we believe is at odds vs. its distribution peers as well as the ROCE delivered of 28%. We remain comfortable with the assumptions made in our initiation note in December. The average share price outcome based on our valuation techniques pointed towards an intrinsic value in excess of 809p, which we believe is achievable within a three-year time horizon, which implies 41% upside from current levels.
