Is Cabcharge Australia Limited a buy?

Is this an opportunity to hitch a ride with Cabcharge Australia Limited (ASX:CAB)?

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Just 9 months ago shares in Cabcharge Australia Limited (ASX: CAB) hit a high of $6, this week it is trading under $4. A fall of 33% in the share price is significant, but is it an opportunity to buy at a discount to fair value or a "falling knife"?

Cabcharge is engaged in taxi related services, as well as bus and coach services. It is perceived as being vulnerable to both legislative change and disruptive competition.

A significant proportion of Cabcharge's profit has historically been derived from the 10% fee it levied for credit card transactions on its electronic payment system in taxis.

State governments across Australia have progressively moved to legislate this down from 10% to 5%, which has had an impact on the bottom line for Cabcharge. The effect has been mitigated to some extent by an increased turnover due to the impact on smaller competitors.

Operators like Uber have also had a disruptive influence on the traditional taxi industry. It is difficult to determine the long-term impact on the Cabcharge business. Uber faces its own legislative challenges and concerns about passenger safety.

Cabcharge appears to be responding to the challenges in the industry and is increasing its diversification into the bus and coach business. It is also continuing to develop and improve its taxi related businesses including payments, training and communications.

Looking at the historical financials suggests there is value in Cabcharge at the current share price. It is trading at a price-to-earnings ratio of about 9.2, which is well below the market average. The ratio reflects the market's concern about future earnings for Cabcharge. A useful test is to invert the price-to-earnings ratio and consider what the earnings would need to fall to so that the ratio was nearer the market average. In the case of Cabcharge, earnings would have to fall from 43c to 25c per share to give a price-to-earnings ratio of 16.

Based on my discounted cash flow calculations, Cabcharge is worth much more than it is currently trading at. The very high operating margins that it enjoys help contribute to strong free cash flow which in turn underpins the intrinsic value of the company.

Another metric that I like to look at is the equity valuation-to-earnings ratio, at about 10.7 it is nearly half the market average and indicates the market may be mispricing Cabcharge.

I expect the dividends for the full year will be 20c this year, which on current prices would equate to a yield of 5% fully franked.

Cabcharge's debt-to-capital ratio is manageable at 30% and interest coverage is 11.7 – well above my cutoff of 4.

I believe Cabcharge is trading at a discount to true value and provides an opportunity to invest. If it can deliver the planned cost reduction of around $7 million this year it will largely offset the negative impacts on the business and we may see strong growth in the share price again.

Motley Fool contributor Rick Mooney owns shares in Cabcharge Australia Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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