COG Financial Services Screens ‘Too Cheap’

This story features COG FINANCIAL SERVICES LIMITED. For more info SHARE ANALYSIS: COG

A cheap valuation and chunky dividend yield make COG Financial Services a compelling story.

-Setting the macro stage
-In the growth slipstream
-Bolt-ons consolidate market share
-COG Financial Services shares too cheap to ignore

By Danielle Ecuyer

A Christmas rate cut in the offing

As share indices including the ASX200 hit all-time highs, investors may well start to cast their eyes over small cap laggards with scope for some earnings tailwinds from lower interest rates.

Thus far, Commonwealth Bank is one of the bravest to signal inflation will trend down sufficiently towards the end of 2024, allowing RBA Governor Michele Bullock and her board to deliver a surprise cut to the cash rate before Christmas.

Most economists have penciled in February next year, or maybe a little later.

Very few question the next RBA move will be to the downside, exact timing as yet unknown, and this likely opens the door to bombed out share prices of small cap companies on the ASX.

Enter COG Financial Services ((COG)), a rollup that has acquired over twenty companies since January 2020 and spent $292m since December 2015, to evolve into a $194m market cap diversified financial services group.

Acquisitions maketh the company

The company has three main segments, broking and equipment leasing, novated leases, asset management and lending.

The largest segment is broking and aggregation in equipment leasing for small-and-medium sized businesses. It has exposure across all Australian states and territories. NSW and Victoria are the largest.

In FY24, the company owned 795 broking firms, with 1767 brokers, 8637 novated lease customers and 38,584 salary packaging customers.

Bell Potter emphasised at FY24 results in August the company’s “successful” track record in acquiring bolt on acquisitions at attractive valuations, with no signs of a slow down in FY25. Novated leasing is in the target range for management with almost $91m in cash and $3.8m in un-drawn acquisition finance debt available to use.

Casting an eye over the historical financials, Morgans explains COG is Australia’s largest asset finance broker and aggregator. The company has settled since FY16 net asset finance at a 16% compound average growth rate to $8.9bn in the latest FY24 earnings.

Since FY18 the company has expanded its commercial equipment net asset finance market share by a factor of three times to 21% from 7%.

Morgans, which initiated coverage this week, believes COG has a robust strategic position to capitalise on a fragmented sector, leaving the door open to being the only “acquirer” of scale in broking and aggregation locally.

Favourable demographics via immigration, population growth, increasing infrastructure spending, all,underpin positive tailwinds for SME business lending growth which has expanded at an average 5.5% annual rate over the last 20 years.

Lower interest rates would be the icing on the cake.

Recent acquisition Paywise contributed some $18.3m in revenue over FY24 to the novated leasing business and boosted this division’s margins to 11.8%, an increase of 3% on FY23. 

Novated leasing has continued to benefit from the growth in electric vehicle demand with Morgans estimating COG has a relatively small market share of 5% to 10%, offering scope to grow, including via acquisitions. Favourable fringe benefit incentives for electric vehicles should continue to underwrite volume growth, the broker expects.

Digging into the financials

Breaking down the revenue split for the company, finance broking and aggregation was the largest contributor at $281m in FY24, followed by novated leasing at circa $147m and asset management/lending at around $68m.

COG has reported an ongoing decline in its bad debt ratio to 0.45% in FY24 from 1.16% in FY20. Impaired assets have also declined to $3m in the latest results, from $8m in FY20, Morgans highlights, which is a reflection of the improved credit quality, as well as a greater emphasis on loans rather than leases which have more elevated loss rates.

The company’s funds from wholesale markets which means lower interest rates will decrease funding costs and improve net interest margins.

For investors, management targets a 70% payout ratio with the latest estimated dividend yield on offer estimated by Morgans at 9%, calculated off a circa 60% payout ratio.

From a valuation perspective, the stock trades at a notable discount to the small ordinaries index, of eight times prospective price-earnings against 26x times for the index.

Compared to EPS growth expectations of around 12% for COG versus 16% for the index, Morgans, again, believes the discount is excessive in comparison to COG’s growth outlook.

Admittedly, the last two fiscal years earnings haven’t been quite up to investors’ expectations or as Morgans describes “underwhelming” at -10% in FY23 and 0% in FY24. Several factors impacted including lower volume incentives in finance broking and aggregation, higher funding costs in asset management and runoff of the TL Commercial leasing book. Completion of the runoff is expected to generate $5m in cashflow for COG.

COG is covered by three FNArena daily monitored brokers; all with Buy-equivalent ratings. Morgans is the most conservative stressing a “speculative” aspect and the lowest of the targets at $1.25.

Bell Potter’s and Ord Minnett’s targets are $1.75 and $1.63, respectively. All analysts highlight the compelling valuation and consensus forecast dividend yield of 8.9% (pre-franking).

While being upbeat about the company, both Morgans and Bell Potter acknowledge issues such as the complexity of the business; the risks associated with novated leasing and possible regulatory changes, while a bolt-on acquisition strategy comes with its integration and adverse capital allocation decisions.

On balance, many of those perceived risks are viewed as discounted in the share price.

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