Smartgroup Corporation (ASX:SIQ) is a provider of salary packaging and novated leasing products and has a strong presence in all segments of these two markets. The Company also delivers fleet management services to all market segments. These include workforce optimisation solutions to the health sector, share plan administration to the corporate sector, and payroll administration to the corporate and not-for-profit sectors. The Company has a well-diversified client mix that includes Not-for-Profits organisations, Hospitals, Education professionals, Government and Private & Public companies.
The number of customers in both the salary packaging and novated leasing segments has grown significantly since 2013. This is via a combination of organic growth and a number of acquisitions since 2016. Acquisitions have contributed to the strong earnings growth reported recently. They account for around 75% of the increase in earnings for the 12 months to 31 December 2017 (FY17). Despite this, the rate of organic growth is also impressive. In FY17, the organic growth rate was well above the historical organic growth rate.
Investment case for Smartgroup
The key factors underpinning the investment case for SIQ is the Company’s ability to deliver strong organic growth via scale benefits. This involves driving operational efficiency via technology development (which in turn generate margin expansion). They also have an impressive track record in integrating and extracting higher-than-expected synergies from acquisitions.
SIQ completed an equity raising in late February this year. This was to “provide financial flexibility to support organic growth and pursue future acquisitions”. As such, the Company now has significant balance sheet capacity to pursue either a large acquisition or a series of smaller-sized acquisitions.
Given that SIQ has a track record in integrating both large acquisitions in new segments as well as smaller bolt-on acquisitions, we consider that any further acquisitions are likely to be well received by the market. These would boost already-strong earnings growth estimates for FY18 (consensus estimate indicated +20% growth for FY18) and lift earnings growth estimates for FY19. This is because FY19 would benefit from the a full-year contribution from any acquisitions likely to be made in the near-to-short term.
We see little risks to earnings growth forecasts for FY18. In a recent trading update, the Company commented that the business continues to trade well in the calendar year to date. SIQ noted that there have been client renewals and new clients won across the board. The business and IT integration initiatives are also tracking to plan.
Is Smartgroup (ASX:SIQ) now a buy?
The shares are now trading on a 1-year forward P/E multiple of ~18.5x. Relative to the strong earnings growth profile for FY18 and FY19, it is not considered to be excessive. Having said that, weakness in the share price would be preferable. When we look at the chart, it appears as though if we get that weakness, it may be short lived. The shares have spent the first few months of this year consolidating the prior uptrend. This consolidation looks like a symmetrical triangle. The movement higher in the last couple of weeks has seen SIQ break out of this triangular pattern. This means that SIQ is likely to continue the uptrend now and head to new highs. In the short-term though, there is a possibility that it retests the breakout near $11. That retest would be a better entry point for more conservative traders.
Michael Gable is managing director of Fairmont Equities.
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