The share price for McMillan Shakespeare (ASX:MMS) has done well in the last few months. However, investors should be cautious on chasing it up here. Here is a brief analysis from a fundamental and technical perspective.
About McMillan Shakespeare
McMillan Shakespeare is a market-leading provider of salary packaging, novated leasing, asset management and related financial products and services. The Company reports across three segments: Group Remuneration Services (GRS), Asset Management and Retail Financial Services (RFS). The GRS segment, whose primary offering is salary packaging and novated leases, is the main earnings driver.
Key Factors Underpinning Recent Share Price Re-Rating
While the Company’s results for the 12 months to 30 June 2019 (FY19) were at the upper end of the recently-downgraded $87-89m guidance range provided in June 2019, the re-rating in the share price since the results release were due to a number of factors:
1. The GRS segment, which accounts for over 75% of group EBITDA and is considered the highest-quality segment. It reported strong novated lease growth (+7.4%). This highlighted the attractiveness of the GRS segment’s business model given the ongoing decline in new car sales as well as the potential uplift to volumes should a cyclical recovery in new car sales occur. In context, new car sales in Australia have seen 18 consecutive months of negative growth, reflective of industry pressure due to tightening credit conditions.
2. At the FY19 results release, the Company announced that it is undertaking a strategic review of UK Asset Management operations, which continues to struggle. We consider that an asset sale (assuming at a reasonable price) would be well received by the market. This is in light of the macro outlook remaining challenging and the difficulty in forecasting earnings for the UK Asset Management business.
3. Potential for margin expansion from the cost savings program. Further investment in its core business technology platforms led to group EBITDA margin in FY19 declining to 24.2%, from 26.3% in FY18. As these initiatives have the potential to, firstly, reduce the cost of services clients and at the same time redirect staff onto revenue-based tasks, we expect EBITDA margin to progressively expand to ~26% in FY20 and ~28% in FY21.
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4. Debt levels remain manageable. Most of the debt on the balance sheet is in the form of a revolving line of credit, which is used to fund the purchase of assets for the more capital-intensive Asset Management segment. The strong balance sheet position also allows the Company to self-fund growth investments as well as to undertake capital management initiatives, as well as pursue acquisitions. The most recent capital management initiative was an $80m off market share buyback, (announced at the FY19 results release) which is expected to be 7.4-7.8% EPS accretive on a FY19 proforma basis.
McMillan Shakespeare is currently trading on a 1-year forward P/E multiple of ~14x which is slightly above the stock’s long-term multiple. Accordingly, we consider that the re-rating in the share price since the FY19 results release has factored in the above-mentioned attractive fundamentals.
For a further re-rating to occur, the performance of the GRS segment would again need to surprise on the upside. To this end, we note Company comments at the Annual General Meeting in October that market conditions remain challenging and that further weakness in new car sales in September was having an impact on novated growth.
Even if the GRS segment does surprise on the upside once again, there is downside risk to group earnings given that the Asset Management and RFS segments are likely to remain challenged.
After rallying strongly at the end of August, MMS continued to head higher before hitting strong resistance near $17. After being sold off sharply, it is once again making a move back towards that $17. It is once again at risk here and it is not at the right area for investors to be buying it because of the close proximity of overhead resistance. If MMS does fall back from here, then we would be looking for support to come in around the mid $14’s.
Michael Gable is managing director of Fairmont Equities.
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