Slater & Gordon Achieving Critical Mass

This story features SLATER & GORDON LIMITED, and other companies. For more info SHARE ANALYSIS: SGH

-Potential for more UK acquisitions
-Qld competitive but still favourable
-Strong defensive earnings
 

By Eva Brocklehurst

Law firm Slater & Gordon ((SGH)) continues to expand its horizons, both offshore and in Australia. The broadening into general law should enable the company to generate more reliable cash flow and gain access to more opportunities. Morgans notes, up until the recent half year result, Australian general law was a drag on earnings as it did not have the necessary scale for profitability. With scale now in evidence, and with the help of the Schultz Toomey O'Brien acquisition, the division now contributes around $4.2m to earnings and margins should move towards the targeted range of 12-15%.

Brokers are comfortable that full year guidance can be achieved. UK margins are now in line with Australian margins such that in Morgans' view, scale has been reached. Slater & Gordon has announced two new UK acquisitions for GBP18.7m, providing the firm with a dominant position and increased capability in the area of industrial deafness. The two Welsh firms are Cardiff-based personal injury/general law firm Leo Abse & Cohen and the personal injury firm Walker Smith Way. Deutsche Bank estimates the acquisitions will be 4.0% earnings accretive in FY16 and upgrades medium-term forecasts accordingly.

Brokers observe the Australian business held up well in the half, despite some difficulties in Queensland. Macquarie notes the Queensland market is highly competitive, with several substantial operators in the same field. The broker believes Slater & Gordon should trade on a premium to Queensland-based Shine Corporate ((SHJ)) to reflect its diversification, exposure to favourable structural offshore changes and the options associated with market share gains in the UK.

Weak Queensland operations appear to have been offset by a continued strong performance in Victoria and steady operation in the rest of the states where the company operates. Growth in the personal injury segment was weak, in Macquarie's opinion, but the results were supported by a recovery in class actions, progress in conveyancing, estate planning and family law.

Morgans attributes the softness in Queensland to two issues. The rebranding of Trilby Misso into Slater & Gordon has removed a strong Queensland brand from the market and this means the larger players, Shine and Maurice Blackburn have likely picked up some market share. The other issue is the introduction of a threshold test in Queensland work cover claims, which has probably had an impact on volume and margins. The issues are not systemic and, in Morgans view, increased brand awareness should help increase enquiries and support a turnaround in Queensland market share over time.

Macquarie finds the current multiples undemanding, considering the defensive earnings stream and potential upside from UK expansion. The broker expects the firm will focus on growing multi-track work, which is typically more complex and ultimately involves higher margin cases, such as clinical negligence and industrial deafness. Morgans echoes this tune, suspecting that acquisitions will remain a strategic focus.

The share price collapse of Quindell plc represents an opportunity to take market share in the insurance segment in the UK, although there is little clarity on the potential size of any acquisition. Deutsche Bank notes that due diligence is progressing on the acquisition of Quindell's operating assets by Slater & Gordon but it remains preliminary. Slater & Gordon advanced Quindell funds last December for an exclusivity arrangement in respect to the possible disposal of Quindell's legal services business.

Slater & Gordon ended the first half with net debt of $161m and, given the current debt/equity position, any material acquisitions over the rest of the financial year will require equity funding, in Morgans' opinion. The debt amount included a payment of around $22m made to Quindell for work in progress. Quindell generates a significant proportion of revenue from personal injury cases as well as operating in business process services, telecoms, insurance solutions and medico legal reporting. The three brokers on the FNArena database covering the stock all have Buy ratings. Consensus target is $8.08, suggesting 7.4% upside to the last share price.
 

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