Can this bull bar business keep growing in a bull market?


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Key statistics: ASX: ARB

Closing share price 04.09.18: $19.800

52-week high: $23.940


52-week low: $16.300

Most recent dividend: 19.5c

Annual dividend yield: 1.85% Franking: 100%

When I was a teenager we bought a canary yellow Toyota LandCruiser 60 series. Before we headed off to explore the outback, we fitted it out with a steel ARB bull bar and Old Man Emu suspension. They soon proved their worth when we were attacked by a suicidal kangaroo.

Almost 30 years later, ARB is the leading manufacturer and distributer of 4WD accessories.

Back then you might pass one or two vehicles per day when traversing the outback. Now you struggle to find a campsite. SUVs and utes are the highest-selling segment of the motor vehicle market. And ARB has ridden that trend all the way.

Founded in 1975, the company grew on the back of a reputation for tough and reliable products. It listed in 1988. An investment of $1000 at listing would be worth about $400,000 today and also have provided $111,000 worth of dividends for a total return of about $510,000 or 23%pa for 30 years. I wish my dad had bought shares instead of just the bull bar and springs.

The quality of this business is undeniable, and it is a great Australian growth story, but for those who missed that boat what does it mean for an investor who is considering the stock today.

Revenues and profits have been growing at about 10%pa for the past 10 years. The company has operated on a debt-free basis for at least the past 10 years and generates more than enough cash to cover all of its expenses, investment needs and dividend payments. However you choose to measure quality it makes the grade.

The big question mark with ARB is the price. After hitting a high of $23.94 in June the share price retracted 20%. It has since rebounded a little but is still about 18% off its highs. Despite this, on most valuation measures it looks expensive.

It is trading on a PE ratio of 31 times 2018 actual earnings and 26 times 2019 forecast earnings. Those forecasts are also assuming 20% earnings per share growth, which seems very bullish given growth has been averaging around 10% in recent years.

If we assume growth continues at a still very respectable 10%, then the forecast PE ratio would be 28.5. PE ratios of this magnitude are generally indicative of businesses that are growing at very high rates.

Return on equity has also been tapering off. From 30% in 2010 it has now declined to just under 18%. This is still a great result but it does indicate that the business is looking more mature and finding it more difficult to maintain growth at very high levels.

ARB is a fantastic business, well run and very secure. However, the price now resembles a level of optimism that has outrun the business. For an investor today to earn the types of returns that were available in the past, the business would have to do something truly astounding.

Alternatively, if we witness a market correction and the price of ARB falls further still, it may present a rare opportunity to pick up a great business at a respectable price.

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