McMillan Shakespeare: The Slings And Arrows Of Outrageous Fortune

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

– Govt changes rules impacting novated leases
– Up to half MMS revenues affected
– Significant de-rating now expected
 

By Greg Peel

“The current system provides a tax concession to those who mainly use their vehicles for private use,” notes Credit Suisse, “because by default, it assumes a large portion of business use”.

Credit Suisse has found as nice a way to say “rort” as one might achieve. And therein lies the moral to the tale of how the rug might have just been pulled out from under McMillan Shakespeare ((MMS)) and its novated car lease business, which may represent up to half the company’s revenue on broker estimates.

Yesterday the government announced that in order to recoup part of the $3.8bn in budget losses stemming from a shift from carbon tax to emissions trading scheme, the “statutory formula” method of claiming fringe benefits tax on cars will be abolished forthwith. ATO stats show around 528,000 cars using this method for tax claims, of which Citi believes around half are employer-provided cars and the other half employee choice “salary sacrifice” cars.

The bottom line is there are two ways to claim the annual cost of a vehicle used for business purposes. The first is to maintain a logbook detailing usage and cost which can be presented to the ATO and, presumably, can justify up to 100% deductions. Tradies, for example, would fit this bill, or travelling sales reps. The second is to not maintain a logbook but simply declare that a vehicle is used “mostly” for work rather than private use (commuting is not “work”) and thus receive an assumed deduction of 80%.

In the second case, an employee can choose to salary-sacrifice to acquire a leased car and pay fringe benefits tax only on 20% and deduct the rest, as can an employee who is given a car by the employer. Presumably the ATO is happy not to spend time assessing half a million log books, so the government has basically let taxpayers get away with making some rather dodgy claims about car use. Under the new legislation, all employees claiming vehicle deductions will have to keep log books, which might just expose, in the odd case, true work use of less than 80%.

The fact that leasing companies, car manufacturers and even the retail sector in general are absolutely spitting chips about the new rule might provide some insight into just how widespread, and widely known, rorting has actually been.

But this is not a story about ethics. This is a story about the market.

Yesterday McMillan Shakespeare went into a trading halt after its shares plunged 15%. It was a sad day for a company that has proven to be one of the market’s stalwart “all weather” performers, having risen from around $2 per share post GFC to almost $18 before yesterday, and paying solid dividends along the way. It is not McMillan’s fault that it was generating revenue from novated leases that may have been used as a bit of a low level tax rort, but the fact remains that the share price plunge yesterday implies that it was. If those claiming 80% work-use are really using their vehicles for commuting or leisure most of the time, then there is less attraction in leasing a car as the level of deductions would fall and the driver would have to assiduously maintain a logbook.

The struggling, and excessively taxpayer-subsidised car industry is up in arms because the 80/20 rule made it attractive to buy a new car under lease, hence demand will fall (perhaps a second hand car will be preferred, assuming a car will still be needed) and complaints stretch right through to the struggling retail industry, which is looking through to consumers with less tax deduction dollars in their pockets.

McMillan management has already indicated that “the changes, if implemented, will have a material impact on the Company’s business”. They have been implemented. What remains in question is whether or not they will remain implemented.

It would have been interesting to see how much the MMS share price would have suffered if it were Gillard introducing  these changes, and not Rudd. Perhaps they would be dismissed of having a shelf-life of only a couple of months. But now that Rudd has dragged Labor back to 50-50 with the Coalition after preferences, on polling, the election is no longer a given. Moreover, if the Coalition wins it will also be looking for income earners as it will scrap carbon pricing altogether. It is thus quite likely a Coalition government would not change the rules back again. Credit Suisse is ascribing a “high probability” these changes are here to stay.

As is the market, obviously.

Citi has downgraded its rating on MMS to Neutral from Buy. The analysts have not yet changed their earnings forecasts because they are awaiting updated guidance from management. They have, nevertheless, removed valuation premiums from the affected businesses to affect a drop in target price to $16.62 from $18.49.

Citi believes the rule changes will “fundamentally change the growth potential and future profitability of MMS”.

Credit Suisse has downgraded to Underperform from Neutral, and dropped its target to $12.10 from $15.50.  CS believes the changes could cause a “potentially material decline in novated leasing demand due to less attractive tax concessions”. The analysts do not know just what split of MMS’ lease customers are claiming for work/personal, but estimates novated leasing income accounts for around 40-50% of group earnings. A 20-25% downgrade to consensus MMS forecast earnings could follow, says Credit Suisse, or worse.

Goldman Sachs suggests 20-35% of profit. The range of outcomes is quite wide because MMS does not break down their published numbers to a sufficient extent to allow a more accurate assumption. Goldman is also waiting to find out, leaving its Neutral rating and $17.08 target in place for now.

When it comes down to it, yesterday’s 14% fall in MMS only wipes out the previous two months of gains. But then the stock went into a trading halt. Problem is, this is not just a little setback. It represents a fundamental shift in MMS’s prospects.

There is always a risk in investing in companies for which earnings are heavily reliant on favourable government legislation.
 

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