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Morningstar | Policy Stimulus May Provide a Short-Term Boost to FlexiGroup, but FVE Unchanged

No-moat FlexiGroup’s fair value estimate is unchanged at AUD 1.50 per share despite a potential short-lived boost to financing volumes from recent fiscal and monetary stimulus. We think an ongoing poor macroeconomic backdrop and intensifying competition from digital financing providers will continue to be headwinds. Recent stimulus measures may assist Australian retail sales over the next few months but off a very low base, and we expect any improvements to be temporary. The most recent Australian Bureau of Statistics figures indicate Australian retail sales grew by a lacklustre 0.1% in May 2019, following a fall of 0.1% in April 2019. Retail sales have been trending lower, and on an annualised basis grew by a paltry 2.7% in May 2019, compared with 3.0% in March 2019 and 3.2% in December 2018. Along with falling consumer sentiment, we foresee a generally weak economic backdrop for FlexiGroup to grow its finance receivables.

Nevertheless, in the next few months we expect retail sales to be boosted by the new coalition government’s AUD 158 billion tax-cut package and by the Reserve Bank of Australia, or RBA, rate cuts. The tax package is estimated to result in about 10 million Australians receiving a tax cut of up to AUD 1,080 in coming weeks. This should increase disposable incomes and in combination with the recent 50 basis points RBA rate cuts--most of which were passed on by the banks--should support more retail spending. However, retail sales growth has been weak for several years due to factors we don’t think are likely to materially change over the next few years; like weak wages growth and high household debt-to-disposable-incomes. The RBA recently reduced its estimate of Australia’s non-accelerating inflation rate of unemployment to 4.5% and possibly lower, from 5% previously. With the unemployment rate currently 5.2%, we expect much lower unemployment is required to meaningfully increase wages and retail spending growth.

We think the weak economic backdrop and intensifying competition from digital finance providers that are targeting both consumer and commercial segments will make it difficult for new management to implement FlexiGroup’s four-step transformation plan. This plan includes simplifying products and systems, leading in the buy-now-pay-later segment, streamlining finance applications, and expanding the target consumer--particularly millennials and the thirty- to fifty-year-old cohort who are organised budgeters and confident spenders. In summary, the firm will attempt to attract a larger target audience by providing a seamless experience, a simple fee structure, a wider range of store locations, and a differentiated offer.

We think FlexiGroup’s new buy-now-pay-later installment product “humm” is one of the ways it aims to provide a differentiated offer. This new product is a combination of its core Certegy product that had targeted organised budgeters with average transaction values of about AUD 3,600 and its newer Oxipay product that had targeted millennials with an average transaction value of about AUD 270. Customers of humm will be given much longer repayment options of up to 60 months (compared with Afterpay which is up to two months), and we believe humm is the only buy-now-pay-later installment product that services transactions from AUD 1 to AUD 30,000.

FlexiGroup’s elevated financial leverage will also make it more challenging to implement its new strategy. Gearing (recourse corporate borrowing/owner’s equity less intangibles) hit a recent high of about 70% as at Dec. 31, 2018. However, part of that was due to timing issues including an AUD 300 million Certegy asset backed securitisation that was outstanding at the time and which eventually occurred in March 2019. The December 2018 gearing also does not include a recent placement of about 20 million new FlexiGroup shares to Tanarra Capital Investments, raising about AUD 25 million. Management indicates this equity placement was not about shoring up the balance sheet but about having one of the country’s most astute investment bankers, John Wylie (Tanarra Chairman), join the FlexiGroup board. Nevertheless, we think strengthening the balance sheet is likely to have played a role in this placement. We expect gearing to fall to about 30% to 35% after these transactions. Although more manageable, we think financial leverage is still on the high side given the economic, regulatory, and competitive headwinds faced.