Big Win For Smartgroup

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Brokers hail Smartgroup Corp’s momentum after a big contract win and strong trading update.

-Smartgroup wins big SA government contract
-McMillan Shakespeare the incumbent
-Trading update indicates solid momentum for Smartgroup
-Brokers raise earnings forecasts/targets

By Greg Peel

Smartgroup Corp’s ((SIQ)) success in winning the South Australian government contract for salary packaging and novated leasing is a significant achievement against the long-term incumbent McMillan Shakespeare ((MMS)), Ord Minnett suggests.

After losing the Victorian Department of Education contract in 2022, this is a significant rebound, as the SA government has a 40% larger existing novated leasing base than the Victorian department.

The South Australian Government has appointed Smartgroup as the exclusive administrator of salary packaging services and novated leasing services under an initial five-year agreement (ten years including extensions). The contract will commence 1 July 2024, transitioning from McMillan Shakespeare as the current administrator.

The company did not provide expected revenue from the contract, however stated no meaningful FY24 contribution is expected given the start date, ramp-up of capability pre-contract and leasing sales cycles. Separately, McMillan announced the contract currently accounts for some $16m of revenue. Salary packages would represent a 10% increase on Smartgroup’s current base and leases a 9.6% increase.

Citi estimates the deal is worth $12m in revenue and $6m in earnings on a full run-rate basis, but does not expect a full run-rate to be achieved until 2026 given time is needed to build a presence in South Australia.

Morgans believes a full run-rate can be achieved in 2025. On balance, contract risk looks to remain to the upside, Morgans suggests, with the Tasmanian government’s tender still current for which McMillan is also the incumbent.

Additional investment is needed ahead of launch date and so Ord Minnett expects the impact on 2024 earnings to be minimal, before turning profitable towards the back end of 2024 once vehicles begin to arrive under new novated lease sales executed by Smartgroup.

Trading Update

If the new contract win wasn’t enough, Smartgroup also provided a trading update with fresh 2023 profit guidance ahead of consensus forecasts, as electric vehicle penetration continues to climb, and likely buoyed by the recent increase in new car deliveries.

EV penetration is now more than 40% of all orders for the five months to end-November, and this remains the key driver of sustained organic growth, in Ord Minnett’s view, with cheaper models of EVs only now beginning to roll out (which should assist to broaden the appeal for EVs amongst the employee base).

The trading update highlights the business has invested the current revenue gains heavily into further capability. Morgans expects this is largely in headcount, technology capability and digital marketing. Given the efficiency drag, this is expected to deliver improved conversion and leasing order growth in future periods.

Revenue has grown around 14% half-on-half, largely driven by volumes. Citi expects further organic growth over the next three years, with Smartgroup noting it has been investing for current demand and future growth and forecast lease settlement volumes to grow at a 9.5% compound annual growth rate over 2023-26.

Valuation

All three brokers have increased their earnings forecasts for Smartgroup in the coming years.

Citi expects volume growth and benefits from recent staffing investment to lift earnings margins over 2024-25 but sees potential for further improvements once technology investments are deployed. Citi retains a Buy rating and increases its target price to $10.20 from $9.70.

Ord Minnett also retains Buy, increasing its target to $9.75 from $8.80.

There remains a material opportunity to drive lease uptake and earnings under the current EV policy, which has an expected review date of 2027. However, Morgans views Smartgroup’s valuation has now re-rated to a point which captures the near-term (2024) expectations and thus pulls back to Hold. Target rises to $9.70 from $9.00.

In the short-term, Morgans sees upside risk from the special dividend. The main risk is any unplanned early removal of the current EV policy (election risk), post a period of operational expansion.

Slings and Arrows

While the contract loss is disappointing for McMillan Shakespeare given its scale and earnings impact, Citi remains confident in the potential uplift to novated volumes over the next three years.

The broker expects novated volume growth in the first quarter to have continued in the second, and sees further growth ahead as awareness of novated leasing continues to build.

Citi maintains a Buy rating but lowers its target to $19.50 from $20.50, and also notes uncertainty ahead around the outcomes from the NDIS review.

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