Is this the buy signal for Smartgroup shares?

We recently researched Smartgroup Corporation (ASX:SIQ) in The Dynamic Investor after the Company released results for the 12 months to 31 December 2023 (FY23). The shares have enjoyed a strong re-rating over the last 12 months. Having come off its recent high of around $11 per share, we consider whether current levels present a more attractive entry point.

About Smartgroup Corporation

Smartgroup Corporation provides salary packaging administration and novated leasing services to employees across multiple sectors. These include State and Federal Government departments, Public Benevolent Institutes and corporate employers. Since 2015, SIQ has consolidated the salary packaging sector, completing multiple acquisitions in the sector. These include a further two acquisitions outside salary packaging.

Key Fundamental Drivers

Novated Lease Volumes Supported by Continued Electric Vehicle Penetration

By way of background, in November 2022, the Federal Government legislated the Electric Car Discount bill. This bill provides Fringe Benefits Tax (FBT) exemptions for benefits related to electric cars. Via salary sacrifice arrangements (novated lease), employees will effectively be able to run the cost of the novated lease (including running costs) on a pre-tax basis and not incur FBT.

The introduction of the Electric Car Discount Policy resulted in the penetration of Electric Vehicles (EVs) accelerating in Australia through calendar year 2023. EV penetration has grown from ~15% of SIQ’s total quotes in 4Q22 to 41% at the end of FY23. This reflects the broader take-up across customer segments and improved EV availability (in terms of range and supply).

The potential for the Federal government to offer consumers steep discounts on the price of EV’s in order to meet its emissions targets would be supportive for SIQ’s novated lease volume growth (and EV penetration) over the medium term. That is because such a move would increase the level of cheaper price points as well as improve availability.

Operating Leverage Expected to Return In FY25

Operating leverage in FY23 was impacted as a result of a large increase in operating expenses (+18% in 2H23). This was in response to SIQ adding operating capacity to deliver on demand. The outcome was that profit growth of +3% was well below revenue growth of +12%. Cost growth is expected to continue in 1H24, due to: i) The Company needing to continue increasing capacity to meet demand expense run-rate and ii) Upfront costs and additional resourcing ahead of the commencement of the material South Australian (SA) Government contract on 1 July 2024.

In terms of a potential return in operating leverage over the medium term:

i. A likely acceleration in revenue growth in FY24 (on the back of novated lease momentum) is expected to be tempered by higher cost investment.
ii. The full benefit of the new SA Government contract is expected to flow through in FY25. It is in FY25 when an more meaningful margin expansion is expected. In context, the SA contract will add ~39,000 salary packages and ~5,600 novated leases (or +10% on SIQ’s base levels).

Balance Sheet Capacity to Fund CAPEX & Acquisitions

The balance sheet remains robust, with gearing (on a net debt to EBITDA basis) of 0.3x broadly consistent with recent periods.

Compared to a net debt position of $32m, the Company had available banking facilities totalling ~$82m as at 31 December 2023. Hence, there is balance sheet support to fund: i) Planned CAPEX investment in FY24 (~$11-13m) for technology to accelerate digitisation and scale and ii) Further special dividends. The Company has paid special dividends each year since FY19, in addition to fully franked dividends declared in the last four years reflects the strong cash flows of the business. This is despite vehicle supply impacting earnings over this period.

There is also balance sheet capacity to fund further acquisitions. This could entail either a large acquisition or a series of smaller-sized acquisitions. These 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 an acquisition/s, the gearing level would increase to ~1.0x. This gearing level is still considered comfortable given the Company’s typically strong cash generation.

Fundamental View

Smartgroup shares are currently trading on a 1-year forward P/E multiple of ~17x, which is above the top end of the range over the last five years (11-16x). The premium rating is justified, given:

i) A solid organic revenue growth profile,

ii) A strong EPS growth profile of 9% over FY23-26 on a CAGR basis,

iii) A solid balance sheet, and

iv) Dividend appeal.

In the meantime, the Company is balancing growth with higher operating expenditure and re-investment requirements. In turn, this is limiting the degree of margin expansion over the medium term given that the increased investment is in response to higher demand and cannot be scaled back.

Charting View

SIQ had generally been trading in a channel since August. It broke higher in February, but that failed to hold on and the stock fell back into the old trading range. Now it is at the bottom of the range, it is once again bouncing. This therefore looks like a buying opportunity and investors can place their initial stops just under $9.

Smartgroup Corporation (ASX:SIQ) daily chart
Smartgroup Corporation (ASX:SIQ) daily chart


Michael Gable is managing director of Fairmont Equities.


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