From the AFR - Good overview of MMS and the industry. Salary...

From the AFR - Good overview of MMS and the industry.

Salary packaging group McMillan Shakespeare has gone from market darling to ugly duckling in just over 12 months. As at June 30, 2013, the company’s shares traded at $16.18, implying a price-earnings multiple of 19.8, relative to its 2012-13 profit. While the company had established an impressive record of profitability and earnings growth, its multiple left little room for disappointment, and when this came in the form of proposed changes to fringe benefits tax legislation, the company’s shares plunged more than 60 per cent from an all-time high of $18.64 in July 2013 to $6.75. However, when the coalition won the federal election it put paid to the Labor government’s proposed changes, resulting in McMillan recovering to trade in the vicinity of $14.00 by September. Following this recovery though, the group’s share price has fallen in the past six months, hitting a 12-month low of $8.82 in mid-July. A significant part of the downturn has coincided with the announcement in May that chief executive Michael Kay would be retiring in September. He has been at the helm of the company since May 2008, successfully steering it through the global financial crisis, and engineering acquisitions largely responsible for positioning the group as a market leader, particularly in the area of novated leases. In commenting on Kay’s pending departure, analysts at Citi highlighted how central he has been to the company’s success, saying: “we believe Kay has genuinely contributed to the strategic, economic, financial, service, acquisitive and geographic expansion of the business.” Notwithstanding the loss of Kay, Citi has maintained its buy recommendation and 12-month share price target of $14.83, implying upside of 56 per cent, suggesting it may be buy time. While the consensus 12-month price target of $12.10 is considerably below Citi’s it still represents a premium of 28 per cent to the company’s share price. It is also worth noting Citi has a high opinion of incoming chief executive Mike Salisbury, who has been a key member of the executive team during that same period and who has been instrumental in the expansion and growth of the RemServ business, which incorporates the company’s salary packaging and novated leases business operations.

Acquisitions have played an important role in McMillan’s growth, particularly in the area of novated leases where it is the number one player in Australia with a market share about 50 per cent. Two new players However, the factor that may be equally responsible for McMillan falling out of favour is the emergence of two new players in SG Fleet and Smartgroup Corporation, which listed in March 2014 and July 2014 respectively. Prior to this McMillan was the only ASX-listed pure play salary packaging company. Now McMillan has to compete for the investment dollar there will be a greater focus on peer comparisons, and far less likelihood of the company commanding the heady multiples that have applied historically. Indeed, the company is trading on a much more conservative price-earnings multiple of 10.3 relative to 2014-15 forecasts when it is expected to deliver earnings per share growth of 34.4 per cent.

One of the new players, Smartgroup, has only been trading six weeks, but those who participated in the IPO at $1.60 per share would be disappointed. Within a week of listing, the company’s shares briefly touched a high of $1.57 before hitting a low of $1.41 in the ensuing two weeks. Management estimates Smartgroup has about 20 per cent of the outsourced salary packaging market. The company reckons its diverse product offerings and multiple delivery channels have allowed it to perform well in terms of retaining clients, as well as establishing a win rate of 45 per cent of public tenders between 2007 and 2013. Smartgroup is well represented on the east coast of Australia, accounting for more than 70 per cent of its customers, while its other main area of representation is Western Australia. In calendar year 2013, 60 per cent of revenue was of a recurring nature – an ongoing feature of the company helping to provide earnings visibility. CIMB analyst Matthew Nicholas initiated coverage on the company in early August with an add recommendation and a 12-month price target of $1.75. He highlighted this implies a price-earnings multiple of 9.7 relative to calendar year 2015 forecasts. Based on fundamentals, SG Fleet appears the better option of the two newcomers. The company has mainly traded in a range between $1.60 and $1.80 since listing compared with its IPO price of $1.85. Its current trading range implies a conservative price-earnings multiple of about 11 relative to 2014-15 prospectus forecasts.

However, McMillan’s lengthy record as a strong performing ASX-listed company, only briefly interrupted by the fringe benefits tax scare, makes it look the value play with less risk, particularly trading at levels where further downside appears unlikely.