We recently researched McMillan Shakespeare (ASX:MMS) in The Dynamic Investor and took a positive view, as the shares appeared oversold. With the improvement in the share price since our report, we assess whether the shares still offer value at current levels.
About McMillan Shakespeare
McMillan Shakespeare is a market-leading provider of salary packaging and novated leasing. The Company also has operations in NDIS plan management and asset management. Following a simplification of the business portfolio, the Company’s operations now comprise three segments. These comprise Group Remuneration Services (GRS), Asset Management and Plan & Support Services (PSS). The GRS segment, whose primary offering is salary packaging and novated leases, remains the main earnings driver.
Key Fundamental Drivers
Structural Growth Expected for Novated Lease Volumes
The GRS segment has recently benefitted from the increased take-up of Electric Vehicles (EV). This follows the introduction of the Electric Car Discount Policy. This policy, legislated in November 2022, provides Fringe Benefits Tax (FBT) exemptions for benefits related to EVs. In the 12 months since the introduction of the policy, the portion of MMS’ novated lease orders related to EVs has increased rapidly, to 36%
Further growth in novated leasing volumes is expected, as the take-up of EVs remains at an early stage. In particular, EV availability in Australia remains limited, with only ~37 passenger and SUV models available. Further, it is estimated that ~85% of EVs sold have been below the Luxury Car Tax (LCT) threshold.
Improving Margin Outlook for GRS Segment
EBITDA margin for the GRS segment contracted by ~340 basis points in FY23. This decline was due to an increase in operating costs, which were driven by wage pressures. Other factors included additional head count, elevated costs for carryover orders, and investment in technology and cyber security. In light of the 5.7% Fair Work Commission (FWC) increase from 1 July 2023, EBTIDA margin for the GRS segment in FY24 is expected to remain subdued.
However, over the medium-term, group EBITDA margin is likely to benefit from technology and investment in automation. The increased novated leasing volumes from higher EV take-up further supports margin expansion over the medium term.
Strong Organic Growth Expected for PSS Segment
In FY23, the PSS segment reported revenue and underlying profit growth of +17.7% and +21.3%, respectively. These metrics were supported by a +23% increase in the number of plan management. Importantly, all of this growth was organic.
In addition, there is potential for margin expansion as MMS scales and invests in automation efficiencies.
Balance Sheet Flexibility to Pursue Mergers & Acquisitions
MMS has balance sheet capacity that could support capital management and/or acquisitions, especially in the GRS and PSS segments. As at 30 June 2023, gearing (on a Net Debt to EBITDA basis) was 1.1x. This level is well below its recent peak of 2.5x as at 31 December 2019.
Other balance sheet metrics remain solid. Firstly, interest cover remains high (17x). Secondly, MMS has a diverse source of on- and off-balance sheet funding from major banks in Australia than enable the Company to manage higher gearing levels. Further, balance sheet debt is fully backed by fleet assets and gearing is within covenant levels.
MMS are still looking for the right inorganic opportunities in PSS. However, the market for meaningful acquisitions is shrinking, following competitors acquiring another two of the larger plan managers. The outcome of the current review into the NDIS could be a catalyst for MMS to increase its M&A activity in this segment.
At the time of our recent report, MMS shares were trading on a 1-year forward P/E multiple of ~13.5x, which was broadly in line with the long-term average multiple, but well below recent levels. We did not consider this multiple to be demanding in the context of an EPS growth profile of +10% over FY23-26 on a CAGR basis.
In the short time since our recent report, the multiple has re-rated to ~14.5x. So, we still believe there is value in the shares, especially in light of potential upside risk to medium-term EPS growth forecasts from a stronger-than-expected take-up of EVs and EPS-accretive acquisitions.
MMS spent the first half the year trending nicely, then in August it spiked higher only to be sold down sharply again the next day. That was a clear negative and it lead to a pullback in the share price. However, in late October we saw a strong jump higher on good volumes. The shares then started to trend higher in a sustainable fashion. This price action is very positive and it implies that a low is in place for now and that MMS should continue to trend higher.
Michael Gable is managing director of Fairmont Equities.
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