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Morningstar | McMillan Produced In-Line Fiscal 2018 Results and Foreshadowed Higher Near-Term Investments

No-moat McMillan Shakespeare’s fair value estimate increases moderately to AUD 14.60 per share from AUD 14.20, owing primarily to the time value of money following in-line fiscal 2018 results. Its underlying net profit after tax, or NPAT, of AUD 93.5 million in fiscal 2018 was slightly above our forecast of AUD 92.9 million. In addition, the firm took the opportunity to confirm beginning major investments in fiscal 2019, primarily in its core group remuneration services, or GRS, division, with a project referred to as “Beyond 2020”. While these initiatives heighten the uncertainty over its near-term earnings, we agree with the company’s increased focus in improving the customer experience and generating productivity gains in an increasingly competitive market. It also declared a final dividend of AUD 0.40 per share, taking the full-year dividend to AUD 0.73 fully franked. McMillan currently screens as fairly valued. The “Beyond 2020” project will commence a two-year period of investment in its core GRS segment, improving the technology in its platform and systems. This will lead to higher operational costs and capital expenditures in fiscal 2019 and 2020, and as the name implies, the major benefits are not expected until fiscal 2021 onwards. In response, we forecast GRS’ EBITDA margin to decline to 46.1% in fiscal 2020 from 46.7% in fiscal 2018 and 47.2% in fiscal 2017, before rebounding to 47.0% in fiscal 2021 and then improving to 48.0% in fiscal 2022. The Beyond 2020 investments will create a new cloud-based platform assisting sales by generating a single view of the customer, as well as increasing the speed in delivering GRS’ services and improving operational resilience. The investments will also help customer communications, with the aim of converting more customers into its high-margin novated lease product.

In the near term, McMillan's GRS segment is also likely to be affected by higher employee costs, driven not only by the Beyond 2020 investments, but also by the increased headcount from progressing its Plan Partners project. This is a joint venture with Disability Services Australia to administer the national disability insurance scheme. While this project is still forecast to generate its maiden profit in fiscal 2019, we expect the higher headcount will also weigh on margins.

Its Australian and New Zealand asset management business also performed strongly, with underlying NPAT increasing by 17% in fiscal 2018. However, these results were artificially high due to a one-off termination payment for a broken contract, and we forecast more modest underlying NPAT growth of 5.5% in fiscal 2019. McMillan also expects to increase its investments in its UK asset management business, including making further acquisitions. However, we expect its struggling retail financial services business to face continued margin pressure and heightened regulatory scrutiny, particularly following the 2018 Royal Commission. Accordingly, we do not expect this business to contribute to underlying earnings in any meaningful way in the near to medium term.