This is the second of two articles aiming to identify which of McMillan Shakespeare Limited (ASX: MMS), Smartgroup Corporation Ltd (ASX: SIQ) and SG Fleet Group Ltd (ASX: SGF) is Australia's best salary packaging and fleet management stock.
Acquisitions continued…
SG Fleet has been quieter on the acquisition front than Smartgroup doing just one deal since listing. The company acquired nlc in November 2015 for $154 million or 6.2x 2015 EBITDA which seems like a superior deal to Smartgroup's purchase of Selectus. However unlike Selectus, nlc is not a pure salary packaging services provider as it also offers consumer vehicle finance and vehicle sourcing services.
Since the start of 2015, McMillan has made three acquisitions. The first two were for Presidian Pty Ltd and United Financial Services Pty Ltd (UFS) for a combined $157 million and represent McMillan's entry into the consumer vehicle financial services market. These two businesses could deliver $22.4 million in EBITDA in 2016 based on annualised first half figures.
McMillan's third acquisition was for UK asset finance broker Anglo Scottish Asset Finance for an upfront payment of £7.7 million. It is hoped that the acquisition will boost McMillan's nascent UK fleet management business.
SG Fleet also has a small business in the UK which appears to be a more mature market than Australia. It is estimated that management of 76% of company owned cars is outsourced in the UK versus 36% in Australia suggesting that there is less potential for market expansion. However, the novated lease market is still in its infancy in the UK as legislation similar to that in Australia was only introduced in 2008.
Financials & valuation
Smartgroup recorded a normalised after tax profit margin of 28.5% for financial year 2015, versus 34.6% for SG Group and 17.2% for McMillan in the first half of 2016. The margin in McMillan's Group Remuneration Services division, which provides salary packaging services was 31%, which highlights the strength of this part of the business.
Unlike McMillan, SG Fleet manages to maintain high profit margins across the group despite having a large fleet management division alongside its salary packing offering. This could reflect the fact that McMillan self-finances leases rather than using third parties like Smartgroup and SG Fleet.
The respective balance sheets paint a similar story. Following the purchase of Selectus, Smartgroup will have $115.6 million of net debt entirely due to recent acquisitions. At 31 December 2015 SG Fleet had $77.4 million of net debt related to the acquisition of nlc. Meanwhile, McMillan had $265.4 million of net debt at 31 December 2015 with most of this used to fund fleet assets.
Smartgroup and SG Fleet enjoy strong free cash flows because the services they provide are either paid in advance or on an ongoing basis. This is also true of McMillan but its free cash flow suffers from having to pay upfront for assets that are then leased to clients.
I estimate that annualised underlying net profit after tax (NPAT) is $50 million for Smartgroup, $55 million for SG Fleet and $84 million for McMillan. Therefore, Smartgroup's enterprise value-to-earnings ratio (EV/E) is 19, SG Fleet's is 20 and McMillan's is 17.
Verdict
I would say that Smartgroup and SG Fleet deserve the slight valuation premium to McMillan that the market currently attributes to them due to their capital light business models. However, this may change if McMillan is successful in offloading its leases to third party finance providers in the future.
I am wary of the recent foray into consumer financial services by both McMillan and SG Fleet and would prefer it if they focused on salary packaging. Smartgroup's management estimates that just 550,000 employees out of more than 12 million currently utilise such services in Australia.
I expect this number to increase due to the benefits of outsourcing such a complex, yet non-core function for most employers. Therefore, despite the ever present regulatory risks associated with salary packaging, my favourite business is Smartgroup as it provides the purest exposure to this maturing industry.
