Strong Growth Potential Outweighs Concerns For SG Fleet

This story features SG FLEET GROUP LIMITED. For more info SHARE ANALYSIS: SGF

-nlc a significant earnings driver
-Multi-pronged growth strategy
-Is regulatory risk factored in adequately?
 

By Eva Brocklehurst

SG Fleet ((SGF)) has batted away most concerns over regulatory changes, delivering a first half result which produced a 9.2% increase in revenue, some new customers and a promising start to contributions from its latest acquisition.

The vehicle fleet manager and salary packager continues to to demonstrate margin growth in a competitive and fickle business environment, Bell Potter observes. The broker believes the acquisition of nlc will be a significant driver of earnings in the near term.

Nlc is is a novated lease and vehicle procurement specialist purchased for an enterprise value of $162.4m. This will expose the company further to the novated leasing segment, which already accounts for 26% of vehicles under management.

There is also upside for SG Fleet from more outsourcing tenders, with revenue growth remaining well diversified and a core strength of the company, in Bell Potter's opinion. The broker, not one of the eight brokers monitored daily on the FNArena database, has a Buy rating and $4.20 target.

Macquarie notes nlc generated $4.1m in revenue in its first month of ownership. Organic growth of 10.6% in management and maintenance revenue was partially offset by a 5.0% fall in underlying funding commissions in the half. This was driven by a shift in mix away from commercial vehicles. Furthermore, 65% of nlc's FY15 revenue came from finance commissions. This business has a much higher proportion of commission revenue than the existing SG Fleet business.

SG Fleet has a multi-level growth strategy which stands it in good stead, in the broker's opinion, as it benefits from the trend towards outsourcing, identifying opportunities to convert to full leasing, making market share gains and increasing customer penetration. The business is also light on capital needs, as vehicles are financed off balance sheet under principal and agency-style agreement.

Goldman Sachs is also impressed with the upside potential from the nlc acquisition. Annual synergies after three years ownership are potentially 24-32% of nlc's FY15 earnings. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, considers compound growth rates of 19% over FY15-18 attractive but retains a Neutral rating, given the stock is trading broadly in line with the ASX Small Industrials.

Moreover, whilst such strong growth rates typically warrant a price/earnings premium, the broker is mindful that 40% of earnings are derived from novated leases, which rely on specific tax concessions. On this subject, Morgan Stanley believes the market is ascribing too high a probability for a major change to FBT legislation – one that would end novated leasing – and is also overestimating residual values from changes to vehicle importation laws.

The federal government is not expected to make wide ranging changes or remove novated leasing and the benefit from any means testing or limiting access by employer type would be significantly outweighed by the likely cost, in Morgan Stanley's opinion.

There are also a number of reasons why the broker believes the residual value risk in the potential changes to new vehicle importation is being overstated. Residual value risk is primarily about the speed of change, not the quantum, given fleet managers use real-time analysis and market modelling when setting residual values.

The broker believes it will take more years than the government estimates to reach the expected run rate, given the savings apply to very high end luxury cars. To which fleet managers, incidentally, have low exposure.

There is also the likelihood of a long period of ramp-up before the legislation has any impact on the industry. Importantly the restrictions around used vehicles have not been changed and therefore impact on the Australian market is muted in comparison to the situation in New Zealand, for example.

Even adjusting for the increased risk profile, Morgan Stanley, does not believe the current valuation reflects the company's strong underlying investment characteristics, nor its enhanced prospects in a market where growth is generally lacklustre.

Despite a downward trend in business sentiment in Australia and increasing competition the broker considers SG Fleet to be well positioned to deliver organic growth. This should come from a variety of sources such as internal conversion of customers to full maintenance of fleet management, from outsourcing trends by government and from new business. New Zealand and UK divisions are expected to be net positive contributors to FY17 earnings.

FNArena's database shows three Buy ratings. The consensus target is $3.99, signalling 10.9% upside to the last share price.
 

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