McMillan Shakespeare Dilutes Regulatory Risk

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

-Potential cost, revenue synergies
-And dilutes exposure to FBT policy
-Still, high exposure to one client
 

By Eva Brocklehurst

McMillan Shakespeare ((MMS)) continues to make good on its intention to diversify, acquiring second-hand car finance company United Financial Services for $42m, including 60% cash and 40% scrip.

This financial agency and brokerage specialises in the delivery of consumer and commercial finance and insurance with a focus on used vehicles. Pro-forma revenue and earnings are expected to be $41.3m and $5.3m respectively for FY15, generating a 13% margin.

The latest transaction furthers the company’s foray into used vehicle financing after the acquisition of Presidian early this year. UFS is a similar light aggregator type of business but without the warranty offering of Presidian. Brokers envisage cost and revenue synergy opportunities down the track such as cross-selling of warranty and after-market services.

UFS has 1,900 dealers, 150 finance brokers and 28 branches in its network. Presidian’s comparable numbers are 2,500 dealers, 450 finance brokers and around 94 outlets respectively. While geographies overlap, the UFS acquisition will expand the company’s footprint by adding more scale in NSW.

McMillan Shakespeare’s business model offers high returns with substantial medium-term growth opportunities. Still, both Citi and Macquarie agree that in order to regain a premium rating, the business will need to reduce reliance on Fringe Benefits Tax legislation, which remains vulnerable to the vagaries of government policy.

The brokers also maintain that the cost of debt leverage the company likely gains from having greater scale may have implications. UFS could obtain access to lower rates now it is part of the McMillan Shakespeare group and, in turn, there should be better volume discounts/benefits from the addition for the new owner.

Macquarie observes, with Presidian recording $75.4m in revenue and $14.4m in earnings and generating a 19% margin, access to more attractive financing arrangements and cross-selling could improve the UFS margin closer to Presidian’s over time.

Citi reiterates a Buy call and increases its target to $16.35 from $15.49 as profit upgrades are made and valuation is rolled forward. Citi also includes the issue of 4.3m shares into its forecasts which relate to the Presidian acquisition, a primary driver of earnings dilution in upgraded forecasts.

The broker cautions the stock remains highly leveraged to government-incentivised benefits and, while having a number of strong traits such as positive cash flow and long-term contracts, there is concentration risk. One client, the Queensland government, still represents over 30% of total salary packaging.

Macquarie retains an Outperform rating and raises the target to $14.94 from $13.45. Credit Suisse also rates the stock Outperform with a $13.15 target but has not updated commentary since the Presidian acquisition.

This brings up three Buy ratings on FNArena’s database with a consensus target of $14.81, signalling 9.6% upside to the last share price. This compares with $14.03 ahead of this latest acquisition. The dividend yield on FY16 forecasts is 4.6%.
 

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