We recently researched Smartgroup Corporation (ASX:SIQ) in The Dynamic Investor. This followed weakness in the share price from a high of $8.43 per share in early March, on the back of market concerns relating to several factors. These include the cessation of the electric vehicle exemption, federal election delaying decisions and slowing like-for-like order growth. Are these factors starting to be reflected in the share price; or is the risk-reward balance unfavourable?

About Smartgroup Corporation

Smartgroup Corporation provides salary packaging administration and novated leasing services to employees across various sectors. In more recent years, the group has expanded its service offering in Fleet Management, PBI Fleet Solutions, Payroll Solutions and Share Plan Administration.

Key Fundamental Drivers

Favourable Operational Outlook Despite Headwinds

The Company’s outlook for the near-term remains positive, supported by strong contract wins and demand. This is despite headwinds from factors such as continued high interest rates and inflation, international events and the Plug-In Hybrid Electric Vehicle (PHEV) incentive ending on 31 March 2025.

We highlight several factors that support our view for a favourable outlook over the short-to-medium term:

• Post balance date, SIQ has been awarded as the exclusive provider of salary packing and novated leasing to Monash Health under an initial service period of three years.
• That SIQ was able to achieve 2% yield growth (in 2H24 vs 1H24) in the face of EV price wars and dealer discounting was an impressive result. SIQ expects yields to be relatively stable in FY25. However, there is downside risk to yields in FY25 due to continued pricing pressure.
• There has been an improvement (i.e. reduction) in vehicles delivery timeframes. This currently sit above historical levels (>20 days), implying further scope for reduction. Further, there is good availability for existing EV models, with new models expected throughout 2025. The release of more affordable EVs (i.e. <$35,000) support volume growth in FY26.
• SIQ has identified a large addressable market opportunity, which provides a runway for medium term growth. in the last 12 months, the Company served ~541,000 customers (compared with 2.3 million potential customers employed by SIQ clients). The majority of these customers are in Government, Health and Not-For-Profit segments. This under-representation provides SIQ with an opportunity to increase penetration in existing clients, generate additional growth in the corporate segment and acquire new clients.

Margin to Trend Higher

The improvement in the EBITDA margin for the 2nd half of financial year 2024 was driven by operating leverage from recent hires (2H23-1H24), increased novated lease volumes, digital investment in customers. SIQ also reported increased employee productivity.

Pleasingly, the margin expansion was achieved despite total expenses increasing 22% for FY24, mainly due to increasing cost base to meet increased demand. Notably, staff expenses increased by +20% in order to meet resourcing demand in novated leasing and wage inflation.

The Company remains focussed on maintaining operational leverage via: i) Winning additional clients to maximise relationship management teams and scale, ii) Capturing the organic opportunity to expand packaging and benefit penetration; and iii) Expanding products and services to better meet customer needs to increase the retention and further leverage the customer base, thereby driving improved financial results over the medium-term.

Further digital investment and additional technology-based hires in FY25 are likely to keep EBITDA margin relatively flat in FY25 – but underpin the expectation for further EBITDA margin expansion in FY26/27.

Balance Sheet Capacity to Fund Capex & Acquisitions

The balance sheet remains robust, with gearing (on a net debt to EBITDA basis) of 0.4x broadly consistent with recent periods. This is because the Company has maintained small net debt position. Despite a small increase in net debt in order to fund IT development and on balance sheet fleet vehicle leases, there remains significant balance sheet capacity to fund further acquisitions.

Potential acquisitions could entail either a large acquisition or a series of smaller-sized acquisitions. Acquisitions are likely to be well received by the market given the Company’s track record of completing EPS-accretive acquisitions at historically attractive acquisition multiples.

Should SIQ fully utilise its available banking facilities to undertaken acquisitions, the gearing level would increase to ~1.0x. This level of gearing is still considered comfortable given the Company’s typically strong cash generation. Cash flow conversion (103% and 108% in FY23 and FY24, respectively) remains strong and consistent (i.e. >100% over the last seven years).

Fundamental View

SIQ shares are currently trading on a 1-year forward P/E multiple of ~12.5x, which is at the bottom end of the trading range over the last six years (11-16x). The current multiple is not overly demanding in the context of an EPS growth profile of ~6% over FY24-27 on a CAGR basis.

Despite market concerns about a more challenging operating environment, we contend that the potential for margin expansion, as well as likely acquisitions underpin investment appeal at current levels.

Charting View

The decline in March saw SIQ break under support near $7.50. The past several days has seen it rally back up to that old support level and it is now retesting it. We have buy signals on the MACD and daily RSI. A break above this line would be the buy trigger from a charting point of view. Otherwise we may see the share price drift lower first.

 

Michael Gable is managing director of Fairmont Equities.

 

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