Thorn Group Diversification On Track

This story features THORN GROUP LIMITED. For more info SHARE ANALYSIS: TGA

-48-month contract gains traction
-Potential from small business incentives
-Work still needed in financial services
 

By Eva Brocklehurst

Thorn Group ((TGA)) continues to expect receivables expansion will be the basis for growth in all parts of the business. The company intends to review acquisition opportunities as it progresses a strategy of diversifying operations.

FY15 results revealed growth of 14% in its core division, Radio Rentals, supported by what Morgans believes is a more meaningful contribution from equipment finance. Radio Rentals is experiencing robust take-up of its 48-month Rent-Try-Buy contract, with 76.3% of finance leases originated under the contract. Technology products and the development of leasing packages are solid contributors. The broker is mindful that growth rates will be offset going forward by factors such as the cycling of the impact of the 48-month contract introduction and a lower Australian dollar.

The company is also investing in re-branding which may be a drag on earnings. On this basis, Morgans believes the growth rate for Radio Rentals is likely to edge back to 2-6% in FY16. Macquarie also hails the success of the 48-month Rent-Try-Buy contract, which was introduced 16 months ago. The product makes large ticket items more affordable by spreading the payments over a longer period and categories such as whole-of-room furniture have accelerated. The company has observed a shift in product mix towards larger white goods and furniture.

If the newer businesses, equipment finance and financial services are evaluated together they generated a return of 7.0% in FY15, Goldman Sachs maintains. Continued improvement is expected, therefore, as these divisions approach a critical mass. The broker upgrades FY16-17 earnings estimates by 5-8% on the back of the results, reflecting higher rental asset installations and improved returns from equipment finance. Goldman Sachs has a Neutral rating and raises its target by 9.0% to $2.84.

The outlook for equipment finance is positive and the majority of organic growth in FY16 is expected to come from this division. There is also the potential for stronger volumes from the federal government’s small business tax incentives. Goldman Sachs was surprised at the substantial growth in cash costs in equipment finance, which suggests less operating leverage than previously assumed. Cash Resources Australia contributed $800,000 in profit in the four months under Thorn’s ownership and management remains confident of the cross-selling opportunities.

There is still work to be done in financial services, Morgans observes, as this division has suffered from higher bad debts and a high cost of customer acquisition. Overall, the broker considers the return on capital of around 3.5% is sub par. NCML and consumer finance divisions were also disappointing but Morgans envisages minimal downside risk to the current earnings base.

The federal government has signalled changes to consumer lease regulations which remove the indefinite lease loophole, Goldman Sachs observes. The majority of the company’s products are contracted on 18-48 month terms and so the broker considers Thorn Group will be largely unimpeded by the changes. In fact, its competitive position may improve as several of its smaller competitors exploited previous arrangements.

Morgans downgrades its recommendation to Hold from Add as the stock is now trading close to valuation, with a $3.09 target, but remains positive about the earnings outlook in FY16. Macquarie retains a Neutral rating and $2.90 target and considers the current valuation adequately reflects the benefits of diversification but also the potential risks around regulatory issues.

FNArena’s database has three Hold ratings for Thorn Group (not including Goldman Sachs) with a consensus target of $2.95, which suggests 2.0% upside to the last share price. The dividend yield on FY16 and FY17 estimates is 4.5% and 4.7% respectively.
 

Find out why FNArena subscribers like the service so much: “Your Feedback (Thank You)” – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms