EUR 850.00 For Business Accounts Only

Morningstar | FXL Updated Star Rating from 22 Aug 2018

We are more confident in no-moat Flexigroup’s turnaround following better-than-expected fiscal 2018 earnings and an improved outlook. This prompts a material increase in its fair value estimate to AUD 2.65 per share, from AUD 1.90. The company’s fiscal 2018 underlying net profit after tax, or NPAT, of AUD 88.2 million was at the top end of its guidance and better than our forecast of AUD 85.6 million. The firm’s investments in the past few years in digitising, simplifying, and optimising its business are beginning to gain traction, supporting an upgrade in our underlying NPAT forecast in fiscal 2019 to AUD 96.4 million from AUD 89.6 million, within the company’s new guidance of AUD 95 million-AUD 100 million. The company also declared a final dividend of AUD 3.85 cents per share, resulting in a full-year fully franked dividend of AUD 7.7 cents. At our fair value estimate, the company is trading on a fiscal 2019 P/E of 10.3 times and a dividend yield of 3.4%. It screens as undervalued but with a high uncertainty rating.

We were concerned about the progress of Flexigroup’s turnaround following the recent surprise departure of Symon Brewis-Weston as its CEO, just at the point when the company’s recent investments were expected to bear fruit. However, the company’s strong earnings update, including its stronger balance sheet, has alleviated these concerns. We expect most of the company’s segments to support stronger earnings growth in fiscal 2019, including its Australian and New Zealand card business, Australian commercial leasing, and the Certegy business. The reduction in corporate debt was another feature of the results, with its gearing; corporate debt as a percentage of equity excluding intangible assets, continuing to decrease to 36% at year-end fiscal 2018, from an uncomfortably high 67% at year-end fiscal 2016. We expect the company to continue focusing on progressively reducing its corporate debt, forecasting gearing of about 10% by the end of fiscal 2023.

We also believe the completion of the end-to-end digitisation of the Certegy business across the company’s seller network in 2018 should see it return to earnings growth in fiscal 2019. This digitisation includes an on-boarding process that is reduced to 3 minutes from the previous 10 minutes and settlements that now complete within 24 hours, when it previously took up to 7 days. This has led to extremely high customer advocacy scores, with net promoter scores consistently above 50. This underpins our increased confidence in the turnaround of this business. Higher expected earnings growth is also driven by its recent investments in improving productivity. This includes consolidating back-end systems and marketing teams, as well as centralising data analytics. These investments are expected to generate operating cost savings of about AUD 8 million annually from fiscal 2019, although some of these cost savings may be invested back into the business. The company also showed strong progress in rebuilding its Australian commercial leasing business, with NPAT up 15% in fiscal 2018.

One of the more negative aspects of the fiscal 2018 result was the company’s continued inability to convert strong volume and receivables growth in its Australian cards business into NPAT growth. The continued high proportion of interest-free receivables, as well as a collections issue that increased impairments in this business, led to lower-than-expected NPAT growth. However, we expect a higher proportion of receivables to convert into interest-bearing from fiscal 2019 generating higher NPAT. It’s also not unusual for impairments to increase when card receivables grow at elevated levels--in Flexigroup’s case by 34.1% in fiscal 2016, 55.3% in fiscal 2017, and 34.3% in fiscal 2018. Overall impairments, inclusive of Australian credit card impairments, as a percentage of receivables were only modestly higher at 3% in fiscal 2018, from 2.9% in fiscal 2019. The company also indicated that it intends to make further investments into its collections processes.

Flexigroup still faces several headwinds including subdued retail spending growth in Australia; increased regulation, especially in its consumer leasing business; and continued challenges to its traditional brick-and-mortar distribution partners from online competitors, as well as facing competition itself from new digital financing businesses. While this economic environment explains the company’s high uncertainty rating, we believe its recent investments place the company in a stronger position to meet these headwinds.