Overwhelming Relief At McMillan Shakespeare

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

-Some hangover likely in FY14
-Ramp up to profitable growth expected
-Heightened sensitivity to remain
 

By Eva Brocklehurst

The federal election is over and leasing and salary packaging consultant, McMillan Shakespeare ((MMS)), is breathing a sigh of relief. The former Labor government had intended to take the razor to the fringe benefits scheme, which would have substantially affected individual salary packaging and novated leasing. These items form a large part of McMillan Shakespeare's business. There was a rush to downgrade the stock among analysts. Then, as the Labor government increasingly looked a lost cause, the views started to improve. The incoming Coalition had stated those changes to the Fringe Benefits Tax would not be made.

Citi has reviewed the stock after the election and the company's update and finds there will be a some hangover in FY14 as a result of the uncertainty created by the former government's intentions. The broker retains a Buy rating. Credit Suisse, another broker covering the stock on the FNArena database, re-rated the stock back to Neutral from Underperform in the wake of the August financial results and the increasing likelihood of a Coalition victory. BA-Merrill Lynch slashed forecasts, downgrading to Underperform from Buy, in the wake of the Labor plans and is yet to update on the stock. The company had imposed a ban on communications with analysts, shareholders and the press until after the election when its position would become clearer.

McMillan Shakespeare could not sell new employer novated leasing contracts after July 16 or implement some of those won prior to that date until the quantum of planned changes, or abandonment thereof, was known. Business should now be returning to normal but there will be a ramp up. Corporate clients that shut down their programs may need to agree to re-start and individual clients need to be reassured. Citi observes, even with business as usual, there is a 42-day novated lease cycle.

Outside of this, the company expects ongoing profitable growth in remuneration services through new contracts and participation growth. McMillan Shakespeare is also confident about the UK joint venture, where it has secured a GBP15m credit line to help fund its 50% stake.

Goldman Sachs believes it is too early to say whether the recent regulatory uncertainty for novated leasing may have put off potential customers, or has actually raised awareness of novated leasing. This is where there may be some upside for the stock. Some customers terminated novated leases and their return may therefore take some time. The broker estimates vehicle re-marketing profits fell to 9% from 12% of group earnings in FY13. A pick up in FY14 is expected with more vehicles coming off lease, bolstered by vehicles where the lease conclusions were deferred from FY13 because of the weak economic environment.

Goldman has reduced FY14 earnings estimates by 7%, reflecting a slower ramp up in novated leases, but has increased FY15/16 estimates by 5% reflecting lower funding costs and a pick up in vehicle re-sale profits, because more vehicles will come off lease in FY14. Citi has no doubt the first half of FY14 will be volatile. FY14 profit is expected to fall 22% to $48.5m. This assumes no business is written in new sales or renewals for the first four months of FY14, approximating the time between the Labor government's FBT policy announcement and the election, and the length of a novated lease cycle.

The issue has also raised the sensitivity bar of the stock. Any future review of taxation conducted by the incoming government means a light will also be cast in McMillan Shakespeare's direction, in Goldman's view. Citi also notes, being a small cap stock which is highly leveraged to one theme, ie government incentivised benefits, this remains a key risk. It has a number of positive traits including strong operating cash flows, solid debt covenant coverage, and medium-term visibility because of the long-term nature of the contracts. Citi observes there is also a concentration risk, with one client, the Queensland government, representing over 30% of total packages.

In Citi's summation, given the entire industry was subjected to the regulatory volatility, McMillan Shakespeare should be well placed to regain previous momentum in due course, although any profits generated may reflect less of a price/earnings premium given the potential to view the stock as not impervious to regulatory risk.
 

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