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Morningstar | FlexiGroup’s FVE Reduced Following Material Downgrade to Earnings Guidance. See Updated Analyst Note from 12 Feb 2019

A material downgrade to its fiscal 2019 guidance, combined with continuing macroeconomic and regulatory headwinds drive a reduction in no-moat FlexiGroup Limited’s fair value estimate to AUD 1.50 per share from AUD 2.05. While we had lowered our earnings forecasts for the company in December 2018 in the face of increasing macroeconomic and regulatory headwinds, the company’s new guidance suggests the extent of these headwinds were underestimated. The company’s new guidance is 20% lower than its previous guidance reiterated only a few months ago on Nov. 16, 2018. The company expects fiscal 2019 cash net profit after tax, or NPAT in the range AUD 76 million-AUD 80 million, from previous guidance of AUD 95 million-AUD 100 million. We now forecast cash NPAT in fiscal 2019 of AUD 76.3 million, at the lower end of its new guidance. At our fair value estimate the company has a fiscal 2019 P/E of 7.3 times and dividend yield of 4.3%. The undemanding P/E reflects the regulatory and macroeconomic risks as well as the competition facing the company.

The voluntary liquidation of one of its vendor partners is the primary driver of its NPAT downgrade, leading to higher provisioning in its commercial leasing business. The liquidation is expected to cause a one-off after-tax provisioning increase of circa AUD 12 million, and underscores company’s sensitivity to the performance of its vendor partners, and the broader macroeconomic environment. Nevertheless, the aftertax AUD 12 million impairment does not explain the full earnings downgrade, which is in the order of circa AUD 20 million. The downgrade is also driven by lower-than-expected growth in its Australian cards business. While receivables in its cards business grew by an impressive 18% year on year in the first of half of fiscal 2019, this was nevertheless below the company’s undisclosed forecast and below our previous growth forecast of 23%. We now forecast Australian cards receivables to grow by 16% in fiscal 2019.

Furthermore, while the updated guidance suggests that the turnaround in its Cetergy business is continuing, with volumes growing by 7% year-on-year, the recent Senate inquiry into credit and financial services poses some near-term risks for this business. FlexiGroup appeared at one of the Inquiry hearings on Jan. 22, 2019. At the hearing the company’s representatives were questioned on things like aggressive sales tactics of some of its retail partners in the solar industry that originate its Cetergy buy-now-pay-later financing product as well as some of the incentives provided to sales people who originated its consumer leasing product. While FlexiGroup’s appearance at the Inquiry did not garner any major political or media fallout, we expect this is just the precursor of an era of increased political and regulatory scrutiny over financial services companies more generally following the Royal Commission into Financial Services. The increased regulatory scrutiny, in combination with macroeconomic factors such as expected lower retail sales growth is likely to be a headwind for receivables growth as well as the revenue earned on receivables.

The Senate Inquiry report is due in a few weeks; by Feb. 22, 2019. The company’s new management team have also indicated they will be updating the market on key elements of the company’s new strategy when it releases fiscal 2019 half-yearly results on Feb. 26, 2019.