Company Reports

We lower our fair value estimate for no-moat McMillan by 5% to AUD 18 per share, mainly due to lower revenue growth expectations. Fiscal 2024 results were below our forecasts. Underlying net profit after tax and acquisition amortization increased 38% but missed our forecast by 4%. EBITDA margins improved across all segments, but not as much as we hoped.

McMillan Shakespeare is a business services provider, with salary packaging, novated leasing, fleet management, and disability plan management its key offerings. Together with Smartgroup, it dominates Australia’s salary packaging market, and has a sizable presence in the novated leasing market. Entities in the government, healthcare, and not-for-profit industries make up 97% of McMillan’s salary packaging client base. These industries are defensive and have favorable fringe benefits tax exemptions. They are regular users of McMillan’s services, and underpin the firm's steady revenue.

We initiate coverage on McMillan Shakespeare with a fair value estimate of AUD 19 per share and assign the group no-moat, High Uncertainty, and Standard Capital Allocation ratings. McMillan is a business services provider with salary packaging, novated leasing, fleet management, and disability plan management as its key offerings. McMillan dominates Australia’s salary packaging market with no-moat-rated Smartgroup, and is Australia’s largest provider of novated leasing services by volumes, marginally ahead of Smartgroup and SG Fleet.

McMillan Shakespeare is a business services provider, with salary packaging, novated leasing, fleet management, and disability plan management its key offerings. Together with Smartgroup, it dominates Australia’s salary packaging market, and has a sizable presence in the novated leasing market. Entities in the government, healthcare, and not-for-profit industries make up 97% of McMillan’s salary packaging client base. These industries are defensive and have favorable fringe benefits tax exemptions. They are regular users of McMillan’s services, and underpin the firm's steady revenue.

As foreshadowed in our note on April 2, 2020, we cease coverage on McMillan Shakespeare. We periodically adjust our coverage as necessary based on stock outlook, client demand and investor interest. The largest near-term risk is an economic downturn which will see higher unemployment and a recession, reducing demand for salary packaging and novated leases for new case. Another uncertainty is with potential changes to current fringe benefits tax, or FBT, concessions, which could be revisited in the future in the face of federal budget deficits. Potential major changes to the FBT regime could compromise the high growth and returns historically achieved by McMillan.

We are placing no-moat McMillan Shakespeare under review, with the intention to cease coverage in April 2020. Coverage has been transferred to a new analyst during this period. We provide broad coverage of more than 1,500 companies globally and periodically adjust our coverage according to investor interest and staffing.

No-moat McMillan Shakespeare reported a weak first-half result, impacted by low business and consumer confidence in the United Kingdom and weak new car sales and tighter lending standards in Australia. However, we haven’t materially changed our long-term thesis of continuing underlying net profit after tax, or UNPAT, growth in the company’s core group remuneration services, or GRS business, which comprises around 82% of group profit and is the primary driver of our valuation.

No-moat McMillan Shakespeare’s stronger-than-anticipated second-half performance in fiscal 2019 has stalled in first-half fiscal 2020. Management indicates the company is experiencing more challenging market conditions than expected in Australia, New Zealand and the United Kingdom. The company is continuing to grow its customer base in its core Group Remuneration Services, or GRS, business in both salary packaging and novated leases, but by a slower rate than expected. Continuing weak business and consumer confidence, and particularly weak new car sales are the primary reasons for the disappointing trading performance. The recent federal government tax cuts and RBA interest rate cuts have yet to stimulate demand and it appears the weak economic conditions are likely to persist over fiscal 2020. The trading update drives an approximate 6.5% reduction in our fiscal 2020 underlying net profit after tax, or NPAT, forecast to AUD 85 million, toward the midpoint of management’s earnings guidance of AUD 83 million to AUD 87 million. Our fair value estimate is reduced more modestly by about 5% to AUD 14.20 per share.

No-moat McMillan Shakespeare's strong second-half performance in its core Group Remuneration Services, or GRS, generated better-than-expected fiscal 2019 underlying NPAT of AUD 89 million. This beat our forecast of AUD 87 million. Despite fiscal 2019’s underlying NPAT being 5% lower than 2018, this was a strong result given the macroeconomic and regulatory headwinds it’s facing. Particularly impressive was the 7.4% rise in novated lease sales despite the precipitous 7.8% fall in Australian new car sales during the same period. The solid circa 7% uplift in GRS revenue for the year compensated for the flat revenue generated in its asset management, or AM, business and a fall in its retail financial services, or RFS business. Our confidence in the GRS drives an increase in McMillan’s fair value estimate to AUD 15.00 per share, from AUD 13.50. At our fair value estimate, the company has fiscal 2020 P/E of 13.6 times and a fully franked dividend yield of 5.1%.

We have cut no-moat McMillan Shakespeare’s fair value estimate, or FVE, by about 5% to AUD 13.50 per share from AUD 14.20 following management’s guidance to lower net profit after tax, or NPAT, than consensus estimates. Management forecasts fiscal 2019 underlying NPAT to range from AUD 87 million to AUD 89 million, below current broker consensus of AUD 92 million. We had expected the company to face difficult operating conditions in all three of its segments and previously forecast below consensus underlying NPAT. The update suggests operating conditions were tougher than we accounted for, prompting a reduction in our fiscal 2019 underlying NPAT forecast to AUD 87.1 million, from 90.6 million. The reduction is primarily because of lower-than-expected earnings from its core group remuneration services, or GRS, business. Management blames a challenging retail car market for lower volumes and revenue in its GRS business. The company also faces ongoing headwinds in its smaller Australian and United Kingdom asset management, or AM, and its retail financial services, or RFS, businesses. According to our FVE the company has a fiscal 2019 P/E of 12.9 times and fiscal 2020 P/E of 12.1 times and fully franked dividend yield of 5.4% in both years.

Our fair value estimate for no-moat McMillan Shakespeare is unchanged at AUD 14.20 per share following the company's decision to abandon its proposed merger with Eclipx Group following Eclipx’s most recent earnings downgrade made March 20. The company does not believe extending the scheme completion date will resolve the target’s issues or be in the best interest of McMillan shareholders. We agree with McMillan’s position; we had already assumed the merger would not proceed and removed it from our modelling following Eclipx’s initial earnings downgrade made Jan. 29. Accordingly, the confirmation of the abandonment of the merger does not affect our fair value estimate. At our fair value estimate, McMillan has a fiscal 2019 price/earnings of 13 times and a fully franked dividend yield of 5.1%. At current prices, the company screens as moderately undervalued.

Increasing uncertainty over no-moat McMillan Shakespeare’s proposed merger with Eclipx Group has cast doubt over its ability to achieve its forecast AUD 50 million annual EBITDA synergy benefits. It also faces macro and regulatory headwinds in its asset management, or AM, and retail financial services, or RFS, business--both in Australia and the United Kingdom. These factors have driven a reduction in our fair value estimate to AUD 14.20 per share from AUD 16.60. At our new fair value, the company has a fiscal 2019 P/E of 13 times and fully franked dividend yield of 5.1%.

Increased confidence in the growth prospects of no-moat McMillan Shakespeare’s core high-margin group remuneration services, or GRS, salary packaging and novated leasing business has prompted us to upgrade our fair value estimate to AUD 14.00 per share from AUD 13.00. However, this growth appears to be currently priced in, and shares still screen as overvalued at present.

No-moat McMillan Shakespeare locked in another strong year, delivering 19% growth underlying net profit after tax, or NPAT, to AUD 87.2 million. EPS increased 17.2% to AUD 1.05. The result was boosted by well-performing acquisitions and a good performance from the main division, Group Remuneration Services, or GRS. While the result met our fiscal 2016 NPAT forecast of AUD 87.6 million, we believe a tougher operating environment and absence of acquisitions will result in lower growth in 2017. We are expecting NPAT and EPS growth of 3%.

As McMillan Shakespeare’s salary packaging business was built on laws regarding fringe benefits tax, or FBT, whenever there is a potential change in government, potentially leading to different views on concessions, the risk of a detrimental change increases. While material changes appear unlikely for the foreseeable future, they will remain a lingering risk, contributing to our high earnings uncertainty rating. We make no changes to our AUD 13 fair value estimate, with no-moat McMillan Shakespeare overvalued at the current share price.

McMillan Shakespeare's, or McMillan's, impressive 33.6% increase in first-half fiscal 2016 underlying net profit after tax, or NPAT, to AUD 41.8 million compares with AUD 31.3 million in first-half 2015. The result is a combination of strong organic growth in the core Remuneration Services division, an improvement in the Asset Management businesses, and contributions from recently acquired businesses (Presidian, United Financial Services, and less so, Anglo Scottish). Reported NPAT, which includes the amortisation of acquisition intangibles and one-off acquisition costs, increased 25.1% to AUD 38.9 million. Underlying EPS increased 22.2% to AUD 0.506 per share, impacted by the equity raised to acquire United Financial Services and the exercise of employee options. The fully franked interim dividend increased 16% to AUD 0.29 per share, a 61.6% payout ratio of reported NPAT.

We believe that McMillan Shakespeare remains fairly valued, trading in line with our unchanged AUD 13 per share fair value estimate. The growth outlook for salary packaging and novated leases continues to be positive. Despite regulatory risks, the high-margin, asset-light business model is attractive. We expect growth from increased awareness among employers of the benefits of salary packaging, not-for-profits continuing to outsource, and marketing to employees to lift participation.

The 23% increase in McMillan Shakespeare's fiscal 2015 net profit after tax, or NPAT, to AUD 67.5 million was in line with our AUD 67 million forecast. We maintain our fair value estimate at AUD 13 per share and the shares are slightly overvalued. We believe the market is attracted to McMillan Shakespeare's fully franked dividend yield and record of reliable growth, particularly in the recent uncertain climate. However, we take a more cautious approach to reflect legislative risk associated with the salary packaging business, which underpins our high fair value uncertainty rating. McMillan Shakespeare continues to lack an economic moat, despite returns on invested capital exceeding the weighted-average cost of capital, as legislative risk means the sustainability of investment returns remains uncertain.

McMillan Shakespeare's acquisition of United Financial Services, or UFS, for AUD 42 million is small relative to its AUD 1.1 billion market capitalisation. The transaction will add about AUD 41 million in revenue from fiscal 2016, or a 10% increase on our current forecast. However, earnings before interest and tax, or EBIT, will only increase by about AUD 5 million, or 3%, reflecting UFS's EBITDA margin of 13%, well below McMillan's 50% margins. The transaction is too small to impact our fair value estimate which we maintain at AUD 13 per share. The shares remain fairly valued and we maintain our high fair value uncertainty rating, reflecting legislative risk associated with the salary packaging business. McMillan continues to lack an economic moat, despite returns on invested capital exceeding the weighted-average cost of capital, as legislative risk means the sustainability of investment returns remains uncertain.

McMillan Shakespeare shares have outperformed the benchmark S&P/ASX 200 Index since its interim result in February, rising 5.0% versus the 4.2% market fall. At the interim result, we increased our fair value estimate by 18% to AUD 13 per share, following a change in our valuation methodology. Nonetheless, the shares are now trading broadly in line with fair value.