Northgate (NTG) ... looks vulnerable to an approach

I've bought a few shares in Northgate, the vehicle rental business, at 312p/shr. If I were a private equity house, I would be drooling over NTG.

I reckon NTG presents broadly the same rationale to purchase as did Speedy Hire (SDY), when I got excited about it (Speedily higher) at 30p/shr. 

I like Northgate (NTG, mkt cap £414m) for the following reasons:

1. Debt is much less of a concern: In 2009 it was burdened with debt. Net debt stood at £936m. Three years on and the net debt position had been brought down by £551m to £385m at year end April 2012. It was lower still at the group's interims in October 2012; having fallen to £343m. I reckon it will continue to decline. Indeed net debt is forecast (Bloomberg) to fall to £306m for FY 2013. During this period EBITDA has declined from £363m in 2009, to £291m in 2012 and is forecast (Bloomberg) to be £250m in FY 2013. Net debt/EBITDA has declined from 2.6x in 2009, to a projected 1.2x for FY 2013. In 2014, net debt/EBITDA is forecast (Bloomberg) to ease further to 1.1x. In short, debt is much less of a concern.
   
   
2. It is cheaper now than it was in 2009: Despite serious macro concerns remaining in Northgate's key markets, the UK (c. 75% EBIT) and Spain (c. 25% EBIT), I posit that the outlook is more encouraging than it was in 2009. However, while NTG's market cap has risen by c. £313m since 2009, it is considerably cheaper than it was in 2009. Since then, it has raised £108m via equity and generated £422m of free cash flow during 2010-12. That would suggest c. £217m of cash has not been reflected in its valuation, which equates to 52% of its current market cap. The difference between its 2009 valuation and now is further reflected by NTG's enterprise value, which has fallen from £1,039m in 2009 to its current £776m (see figure below). A further £65m (16% of mkt cap) of free cash flow is expected for 2013.
   
   
3. Strong NAV support: Northgate has a net asset value of 275p/shr, providing strong support to its current price of 312p/shr.
    
4. Significant cash generation through the difficult years: Northgate has continued to generate bags of cash during the weak economic backdrop. Free cash flow after net vehicle sales equated to £172m in 2009, £185m in 2010, £99m in 2011 and £138m in 2012; a total £594m over four years. A further £65m is projected (Bloomberg) for 2013. As highlighted above, debt is becoming much less of a concern. It is worth noting that the group's net interest cost equated to 36p/shr in 2012.
   
   
5. Lowly rated relative to peers: Valuation wise, the shares appear lowly rated on 3x EV/EBITDA (Bloomberg). While serving different rental markets, this compares to the equipment renters Speedy Hire (SDY, mkt cap £263m) on 4.5x, Ashtead (AHT, mkt cap £3.2bn) on 7.1x, Lavendon (LVD, mkt cap £294m) on 4.8x, VP (VP/, mkt cap £137m) on 4.5x. I.e. it is probably 40% too cheap against the average of the equipment renters.  

The key risk is obviously cyclical. But you never know. Macro tailwinds may come about at some point.

In summary ...

Similarly to Speedy Hire, I like Northgate a lot. Even if the enterprise valuation doesn't re-rate, shareholders should be rewarded as the current value of the enterprise migrates over from the debt to the equity side as the cash generation reduces the former. £600m of free cash flow over four years is a lot for a business which is capitalised at £414m and has an EV of c. £740m. As highlighted above, net interest equated to 36p/shr in 2012. That's 12% of the current share price alone. The projected £65m of free cash flow in 2013 equates to a further 150p/shr or another 48% of NTG's current share price. As I said at the start ... if I were private equity I would be drooling.

Northgate share price
Source: Bloomberg

Northgate net debt reduction compared to EV and Mkt Cap
Source: Bloomberg

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