Shares of WashTec (OTCPK:WHTAF) have corrected 22% since the start of the year, but we don’t see this as a buying opportunity. A close look at the results of the first quarter of fiscal year 2012/2022 shows growing cost pressures that will lower profitability and limit generation of free cash flow. Consensus estimates have stocks trading at PER FY12/2023 15.4x, which seems cheap, but this view seems overly optimistic. We price stocks as a sell.
Founded in 1885 and based in Augsburg, Germany, WashTec AG is a leader in car wash solutions in Europe. Its solutions range from car wash systems with conventional brushes, washing machines and high pressure water jets. Its clientele includes gas companies, car manufacturers and small and medium-sized money warfare companies. There are three manufacturing sites in Germany, one in Denver in the United States, one in the Czech Republic and one site in Shanghai, China.
Geographically, the key market is Europe which contributes 79% of total sales in fiscal year 2012/2021, followed by North America at 17% and Asia-Pacific at 4%. WashTec’s European customers are mainly service station operators who offer on-site car washes.
It’s important to note that WashTec’s dominance in the European market stems in part from Germany’s strict car wash laws. Home car washing is banned in most parts of the country to prevent soap and oil from entering the sewerage system, creating a captive domestic audience. There are over 18,000 car wash locations in Germany compared to over 80,500 in the US – quite a dense network considering the difference in land size. It is said that Germans wash their cars six to nine times a year.
Peers include Daifuku (OTCPK:DFKCY), Otto Christ AG (unlisted), Istobal (unlisted) and NCS National Carwash Solutions (unlisted).
Key financial data, including consensus estimates
Shares of WashTec are down 22% year-to-date despite consensus estimating a flat growth profile for the next 2 years (FY12/2023-FY12/2024). The results for the first quarter of fiscal year 2012/2022 would be robust with revenue growth of 19% year-on-year and an improvement in the EBIT margin year-on-year from 4.1% to 4.6%. Management also indicated that the order backlog was higher than the previous year, which is positive for earnings visibility. In this article, we want to assess whether the recent selloff is a buying opportunity.
Strong in North America, but weaker core European market
Revenue growth in the first quarter of fiscal year 2012/2022 (page 7) was particularly strong in the North American market which recorded 58% year-on-year growth, followed by Asia-Pacific at 30% year-on-year. Although the biggest contributor by volume, sales in Europe were up 12% year-on-year, which is respectable but highlights the relatively mature status of the market – a key driver of sales was car wash chemicals illustrating repeat sales versus new install sales. It should also be noted that the favorable monetary environment helped boost North American sales with the weakening of the Euro (underlying growth was 47% YoY).
From a profitability perspective, Europe and Asia-Pacific saw their margins improve thanks to sales volume. Despite robust sales growth, North America reduced operating loss margins but remained in the red due to increased headcount, material costs, logistics and other expenses related to operation.
It is concerning that the North American market is unable to generate profits in the current recovery environment. Asia-Pacific is primarily China and Australia, and despite high expectations in the past, the former remains a difficult market in which to make material progress for WashTec.
The problems in North America explain why the company raised its sales forecast for the year due to the positive impact of currencies (range of 476-484 million euros compared to 450-470 million euros previously) and lowered EBIT margin expectations by double digits to 8% range from 9%. We examine the reasons for the decline in profitability.
Cost inflation cannot be ignored
The company faces multiple supply problems. There are supply chain issues related to semiconductor shortages and rising transportation costs. The prices of raw materials such as steel and cleaning agents such as sodium lauryl sulphate (due to the shortage of edible oil due to the war in Ukraine) are on the rise. The company purchases excess inventory to ensure manufacturing continues, which puts increased pressure on working capital. These factors explain the drop in profitability forecasts, as well as the drop in expectations (page 8) of free cash flow generation initially from a range of 28 to 32 million euros to 10 to 20 million euros for the exercise in progress.
The company believes it has the power to set prices to offset some of these cost pressures, but there will be a lag in the impact of any price increases. Being able to offset all of the current cost pressure is also unrealistic in our view.
Rising costs will pose a downside risk to WashTec’s profitability. Current consensus estimates seem overly optimistic, especially for operating margins reaching 11.7% in fiscal year 2012/2024. We also believe that car washing is not a basic necessity, and with a cost of living crisis, spending habits will change as people reduce or downgrade to less self-service car washes. Dear.
Consensus estimates have the shares trading at a FY12/2023 P/E of 15.4x and a dividend yield of 5.5%. We believe the consensus is too optimistic and, given the downside risk to earnings, real valuations are less attractive.
The upside risk stems from a significant increase in demand in the North American market. With increasing volumes and favorable currency winds, generating operating profits here could be a game-changer for the company’s medium-term outlook.
If inflationary cost pressures appear to have peaked and are beginning to normalize, WashTec’s profitability outlook will be for a gradual recovery.
The downside risk stems from sustained inflationary cost pressures that would lead to lower profitability.
Changing end-customer spending patterns as car washes become less frequent would be negative for demand for new installations, as well as car wash subscription sales.
WashTec has a strong franchise in its core European market, but its growth potential is limited given its mature market status and current cost pressures. Opportunities for growth abroad look most promising in North America, but this option is also being tested by rising costs. Despite the recent stock price correction, we see no opportunity to invest given the weakening fundamentals. We price stocks as a sell.