Goldman Sachs Likes McMillan Shakespeare

This story features MCMILLAN SHAKESPEARE LIMITED. For more info SHARE ANALYSIS: MMS

– McMillan Shakespeare a market leader in salary packing
– Company has strong earnings growth history
– Further solid growth forecast in coming years
– Goldman Sachs initiates with a Buy rating

By Chris Shaw

McMillan Shakespeare ((MMS)) operates in the salary packaging and vehicle leasing markets, generating 70% of earnings from salary packaging and 30% from leasing operations. Goldman Sachs notes McMillan Shakespeare is comfortably the Australian market leader in salary packaging, enjoying 50% market share. This is around double that of the nearest competitor.

Since 2005, McMillan Shakespeare has enjoyed strong earnings growth, Goldman Sachs noting over the last six years earnings per share (EPS) have grown at a compound rate of 41%. Solid growth is expected to continue, Goldman Sachs estimating compound earnings per share growth of 13% over the next three years.

This growth should be driven in part by expansion in the health and charities sector, where growth has been double that of general employment over the past decade. Cross-selling of novated leases to the operating lease customer base should also provide a boost to earnings.

A further attraction in the view of Goldman Sachs is a high and rising return on equity (ROE). ROE in the Remuneration Services division has consistently been around the 40% mark, a level seen as sustainable given ongoing fixed cost leverage.

While ROE in the Asset Management business is currently around 16%, Goldman Sachs expects this will increase as cross-selling of novated leases to the asset base picks up. A debt funded fleet expansion is also expected to help in this regard. 

Shareholders could also benefit from what Goldman Sachs suggests is an undergeared balance sheet. Debt as a portion of debt plus equity stands at around 50%, well below peer levels of around 80%, so offering scope for management to consider additional growth options going forward.

While any change in regulatory regime with respect to salary packing is a risk for McMillan Shakespeare, Goldman Sachs sees any such changes as unlikely. This is due to both powerful vested interests such as the health sector and charities and the fact it would be very difficult to replace current entitlements with a direct grant system.

Given the potential for continued earnings growth, Goldman Sachs is forecasting earnings per share (EPS) of 71.8c this year and 82.2c in FY13. This compares to consensus EPS forecasts according to the FNArena database of 72.6c and 81.6c respectively.

On Goldman Sachs's numbers, McMillan Shakespeare is trading on a FY12 earnings multiple of 12 times, which is around 10% below its historical average. This appears cheap given the solid earnings growth outlook.

To reflect the value on offer, Goldman Sachs has initiated coverage with a Buy rating.

Others covering McMillan Shakespeare agree, as the FNArena database shows all three brokers to cover the stock rate it as a Buy. For Credit Suisse the attraction is a strong growth platform already in place, while both Citi and BA Merrill Lynch see the perceived impact of the current tax debate as overdone. 

This suggests McMillan Shakespeare is good buying at current levels. Also attractive for investors is the yield on offer, which is 5.3% in FY12 and 5.7% in FY13 based on the earnings estimates of Goldman Sachs. Dividends are currently fully franked.

The consensus price target for McMillan Shakespeare according to the FNArena database is $11.19, broadly in line with the $11.08 target of Goldman Sachs. 

Shares in McMillan Shakespeare today are slightly weaker, trading down 7c at $8.49 as at 1.35pm. This compares to a trading range over the past 12 months of $6.37 to $10.60. The current share price implies upside of better than 30% to the consensus price target according to the FNArena database.

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