The salary packaging and vehicle fleet management company McMillan Shakespeare (ASX: MMS) announced a gain in revenue and profit for 2013, although after the 30 June balance date, a Labor government proposal shook the company’s future earnings, causing its share price to plummet 55% in mid July.
Revenue rose 8.9% from $300.6 million to $327.4 million, and net profits went from $54.3 million to $62.16 — up 14.5%. Earnings per share were $0.82, yet no final dividend was declared due to the uncertainty of future earnings based on the proposed legislative changes to Fringe Benefits Tax calculations.
The company has two major segments — Group Remuneration Services and Asset Management — which are around 50% each in total revenue. However, earnings of group remuneration are about 76% of total earnings, or three times that of asset management.
Understanding how the company makes a majority of its profits also explains why the proposed legislation was a one-two punch to future business. It is not a finance company for vehicle leasing, but it gets its revenue from finance, insurance and ancillary commission revenue when a novated lease is settled.
Then, over the life of the novated lease, it gets further income from such things as salary packaging fees and fleet management fees, as well as trailing finance commissions.
Since many of its customers are government agencies, hospitals, charities and private sector businesses, the extent of its income streams are diverse and extensive, which is why company profits have risen from less than $1 million in 2004 to $62.16 million in 2013.
Net profit margin was at 19%, usually more in recent years, and return on equity over 30%. This a value and growth investor’s dream — strong, stable earnings with high profit margins with connections to large private and public organisations.
Enter the Labor government. In mid-July, the government announced proposed legislation that would change the Fringe Benefits Tax calculations for vehicles under novated leases, taking away the tax advantages companies and employees enjoyed as part of salary packaging.
The company still is trying to estimate the total effect it will have on future earnings because if the legislative changes come to bear on its business, their customers may reduce their levels of fleet financing and management, and vehicle procurement may become the employee’s individual responsibility.
With the share price suddenly down from $18 to $8 in about 10 days, investors who believed the Labor government will lose in the next election, and, therefore, the legislation wasn’t worth the paper it was written on, got a 55% discount on a great money earner. The company went through its own little “GFC”, and the rock bottom price allowed an entry for savvy investors.
The share price has already recovered to $12, and as Labor looks much less likely to win the election, the company may be back to where it was before too long.
This is a classic Warren Buffett-style investment story, a wonderful company making money hand over fist that hits a big pothole of short-term business distress, but still comes out with its core business intact. An investor who knows the company story would have seen this as a time to “buy a dollar for 70 cents”, but in this case the going price was 44 cents. At this price point, your margin of safety for future potential downturns has already been priced in, so if the stock took another big dive, you still would be in the black.
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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.
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