Ritchie Bros. (RBA) has been on fire so far this year, as investors are clearly expecting an uplift in its business, with perhaps many clients willing or forced to sell (some of) their assets. The prospects and actual pick-up of activity is welcomed by investors who like the increased value-added service of the company.

While this is to be applauded, shares have doubled, as these share price gains have far outpaced actual improvements in the results, which means that valuations have risen quite a bit – too much to create appeal here, in my eyes.

Trip Down Memory Lane

I looked at Richie Bros. four years ago, late summer 2016, when this niche player was making a nice bolt-on deal. At the time, I concluded that Ritchie Bros. was a strong growth story, operating in a fragmented yet lucrative auctioneering market. Other than making a bolt-on deal, the company partnered up with Caterpillar (CAT) at the time in an important deal, as it is one of the largest OEMs in the world, making a range of equipment which often shows up at Ritchie’s auctions.

At the time, Ritchie Bros., in its capacity as buyer and auctioneer of industrial equipment, auctioned about $4.25 billion a year in 2015, marking just a 1.2% estimated market share, according to its own estimates. The company took an average “cut” of 12%, thereby generating little over half a billion in revenues from the auctioned amount, with auction sites in North America, Canada and Europe through a total of 44 sites.

Secular growth was impressive, with gross auction proceeds surpassing the billion mark in 1998, hitting $2 billion in 2005, to double again to $4 billion in 2014, comprised out of a combination of fixed and/or variable fees. I noted at the time that Ritchie was optimizing its business model, as the “cut” has risen from 8% to 12% of auction proceeds.

Altogether, shares of Ritchie Bros. traded around 0.7 times gross merchandise value, around 8 times sales and about 20 times earnings pegged at $1.40 per share, with share trading around the $28 mark. This multiple and leverage balance sheet made me a bit cautious, although I liked the track record.

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With shares hitting the $40 mark later in 2016, it seemed that the entry point never arrived, yet late in 2017, shares had fallen back to $25 as I acquired a modest position in the higher twenties.

Fast forwarding to early 2020, it is evident that the company has seen solid growth, as is evident in the 2019 results. Revenues rose 13% to $1.32 billion, comprised out of $804 million in total service revenues from auctions and a little over half a billion in inventory sales. Gross transaction value has only risen to $5.1 billion by now, as the revenue side from Ritchie has grown, mostly because it has moved from just a commission model to a more risky asset-based model as well.

The company reported earnings of $1.36 per share, or $149 million in actual dollar terms, on operating earnings of $223 million. While the earnings per share trends have not seen that much of an improvement, the company has been able to cut net debt to just $290 million, for a 1.0 times leverage ratio.

Despite a lack improvement on an earnings per share basis, valuation multiples had risen a bit with shares trading at $40 at the start of the year.

2020 – Revisited

The initial COVID-19 reaction was one of scare, with shares falling from the low-$40s to $25 in March. First-quarter revenues fell 10% to $273 million due to a big fall in inventory sales, yet with inventory being acquired on the cheap, operating earnings actually improved on an annual basis. Seasonally stronger second-quarter sales fell 1% to $389 million, with similar dynamics resulting in a boost to the bottom line results.

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Because of these results shares rallied to the $50s again in August on the back of the strong second-quarter results, as it is evident that the company is actually a beneficiary of these conditions, and in fact, traded around $6 late October before two big events took place.

Late October, Ritchie Bros. announced that it would acquire Rouse Service in a $275 million deal, which includes a $250 million cash payment and a $25 million stock component. Executives cited complementary data and services to Ritchie’s Bros.’ activities. Rouse provides data intelligence and performance benchmarking solutions under a subscription-based revenue model for rental analytics, equipment sales support and appraisals. The LA-based business employs just 60 in FTE, but these are probably high-value added staff. Unfortunately, no revenue, no profit contribution margins in connection to the deal have been released.

In November, just a week after the Rouse Service acquisition, the company released very promising third-quarter results. The impact of increased auctions as a result of COVID-19 was very apparent in the result, with GTV up 22% to $1.3 billion. Total revenues rose 14% to $331 million, which is basically an understatement with inventory selling prices falling. Revenue growth was accompanied by a spectacular improvement in margins, with operating profit margins up six points to 20% of sales. This allowed quarterly earnings per share to nearly double, as I see a real road map to $2 per share.

The 110 million shares outstanding have risen to $75 following this news flow, resulting in an $8.25 billion equity valuation. Third-quarter net debt of $182 million works down to a $8.4 billion enterprise valuation, yet these are steep valuations. With earnings power trending around $2 per share, equity is trading at 37-38 times earnings, and that is after earnings have seen a big boost already.

This valuation reveals that the latest deal is just a bolt-on acquisition here, with the deal transaction equivalent to 3% of the current enterprise value, although that is after shares of Ritchie Bros. have already doubled this year. The deal with Rouse will furthermore help in transitioning the business model away from a traditional physical auctioneer to more a data intelligence service play.

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This helps the company to generate more margins from own transactions, as well as creates more recurring revenues. All of this should make the business model more profitable and predictable, potentially resulting in higher valuation multiples over time.

The other good news is that valuations have risen so far this year as shares doubled, yet the actual revenue growth has been much more modest, of course, pushing up the valuation multiples along the way. Part of this is driven by lower interest rates, higher valuations, and the anticipation of higher future sales. After all, the impact of COVID-19 is set to have an impact on the corporate world, certainly when banks stop waiving the covenants.

Investors might be discounting that the business is the best of both worlds, doing relatively well in solid economic conditions, while the business could see a boost in adverse economic conditions, yet this “safety” play is a bit overrated.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Via SeekingAlpha.com