EUR 850.00 For Business Accounts Only

Morningstar | MMS Updated Star Rating from 21 Feb 2019

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%.

Following Eclipx Group’s earnings downgrade on Jan. 29, 2019 and postponement of the McMillan and Eclipx merger hearing date, we believe there is not enough clarity to include the proposed merger in our modelling. Amongst other things, Eclipx point to softer retail markets for their flat earnings growth in fiscal 2019 and have instituted a cost reduction program in response. McMillan’s management say they are working co-operatively with Eclipx to gain more information on the earnings downgrade and how it and their newly instituted cost-out program may impact McMillan’s previous forecast synergy benefits. McMillan has forecast AUD 50 million per year of EBITDA synergy benefits commencing in three years from bringing the two companies together. However, given Eclipx’s earnings downgrade and McMillan’s response so far, we don’t believe there is enough certainty the merger will proceed, or the forecast AUD 50 million EBITDA synergies will be achieved to include it in our modelling.

On a more positive note, we expect continued strong earnings growth in McMillan’s core group remuneration services, or GRS, business in fiscal 2019. GRS’ underlying net profit after tax, or NPAT, grew by 9.1% in fiscal 2018 and we forecast moderately lower but still strong 7.8% growth in fiscal 2019. GRS’ high-margin novated leasing business continues to defy a weak macroeconomic backdrop of relatively low retail sales growth and declining new vehicle sales to record a 7% increase in novated vehicle units originated in the first half of fiscal 2019 compared with first-half 2018. Through the half it also renewed several major customers and continues to win new business, including two major university clients at the end of the first-half 2019. GRS should also begin to benefit from its “Beyond 2020” investments in service delivery and productivity gains. Its new Plan Partners which provides funding and payment services to the National Disability Insurance Scheme also earned its first profit in the month of December 2018 and should contribute to underlying NPAT in the second half of fiscal 2019. Earnings growth should also be supported by the usual seasonally higher take-up of salary packaging and novated leases in the second half of the fiscal year.

However, we don’t believe the earnings growth in its GRS business will be able to offset lower earnings in its AM and RFS businesses. Management indicate its AM business in the U.K. is being negatively impacted more than expected by new emissions legislation and an economic slowdown brought on by the political uncertainty related to Brexit. The consensus forecast is for asset finance investments post-Brexit to grow at a modest 2% until 2023. We expect these conditions to foster flat to negative earnings growth in the company’s U.K. AM business over the next few years. Its AM business in Australia is also being impacted by weakening economic conditions, including subdued retail spending and new car sales as well as increased competition. We expect these conditions to drive a 3% fall in underlying NPAT in this business in fiscal 2019.

We also expect regulatory uncertainty over add-on insurance, warranty and financial services products more generally stemming from ASIC investigations and the Financial Services Royal Commission to continue to be a headwind for the company’s Australian RFS business. Some of the impacts of these headwinds were noticeable in the first-half fiscal 2019 results. For example, net claims were up 23.5% from the previous corresponding period due to its new warranty product redesigned to provide more customer value in response to regulatory changes. Management believe the changes since made to their products and services will allow the RFS business to compete more effectively in the new regulatory environment. Notwithstanding, we expect lower earnings in the next few years in RFS due to the regulatory headwinds and our expectations of weakening macroeconomic conditions.