Australia | Oct 23 2014
– Macquarie initiates with Outperform
– Four from four Buy ratings
– Revenue growth to supplement cost efficiencies
– Dividends forecast to recommence
By Greg Peel
For this writer, the memory of Spotless Group ((SPO)) will always be one of queuing for half an hour during a footy match to buy a half-frozen meat pie. But that memory, it would seem, is one of a previous incarnation. In 2012, private equity firm Pacific Equity Partners acquired and de-listed a company in decline, which was tenuously stretched across international operations and weighed down with debt.
PEP sold off Spotless’ offshore operations and aggressively cut costs across the remaining domestic (A&NZ) group. The private equity firm drew criticism and disbelief when it sought to re-float the company through an IPO in May this year, with the naysayers unprepared to believe the mess that was the old Spotless could have been turned around in such a short space of time. It seemed as if the critics were just willing the new Spotless to fail.
Which may go some way to explaining why Spotless continues to trade at an average 8% discount to the price/earnings and enterprise value multiples of global peers, as far as Macquarie’s valuation attests — a point not lost on other brokers. Macquarie yesterday initiated coverage on the new Spotless, setting an Outperform rating. Macquarie joins Citi, UBS and Deutsche Bank among the FNArena database brokers to not only to have restored coverage since Spotless returned, but to have applied a Buy or equivalent recommendation. SPO boasts four from four Buys.
Spotless re-listed in May so the FY14 earnings result released in late August only allowed analysts to check the company’s brief listed performance to date against IPO prospectus forecasts. The result came in marginally ahead of the prospectus and beat all three brokers above who had already initiated coverage.
At the time, UBS noted the “beat” was not just derived from further cost cuts but clearly revenue growth-driven, as the company took advantage of a greater scope of work. It is this “greater scope of work” which has also attracted Macquarie to the story.
Spotless is the leading Australasian provider of facilities management, catering, cleaning and laundry services. The superior scale and breadth of Spotless’ service offerings provides the company with a competitive advantage in the local market, Macquarie suggests. If a corporation or government department were a household, one might consider Spotless the housekeeper, paid to do all those time-consuming and dreary household chores one might be stuck with when there are so many more important things to do. In the twenty-first century, the popular solution is to outsource such obligations.
Indeed, a clear outsourcing trend has emerged downunder, notes Macquarie, particularly in health, education and government services. These three are growing sectors in which spending is being increased, and it makes sense to improve efficiencies by outsourcing certain responsibilities to those who live to handle such matters. Spotless management expects a 9% per annum growth trend over FY13-18 in outsourcing. The resources sector is another area in which cost efficiencies are being aggressively chased, and while Spotless is an immature player in this particular sector, it is rapidly gaining market share from its number three position.
Cost reduction and business improvement in Spotless’ own operations is expected to continue to underpin earnings growth in FY15, Macquarie points out. But the broker does not believe Spotless is “over-earning”. In other words, earnings growth is not expected to come to a screaming halt the day the company runs out of costs to cut or improvements to make. Beyond FY15, Macquarie sees revenue growth as a key earnings driver. Spotless is well-placed to exploit an increasing trend towards integrated and longer term contracts which result in clients becoming more and more “sticky”. It further stands to benefit from an increase in public-private partnership (PPP) arrangements with government departments.
Macquarie expects Spotless can close its valuation gap to global peers by delivering prospectus forecast earnings growth in FY15. Over FY16-17, the broker forecasts 11% per annum earnings growth driven by 6-7% revenue growth and margin improvement.
Macquarie, UBS and Deutsche Bank all forecast “new” Spotless to re-establish dividend payments in FY15 and Deutsche has suggested the possibility of capital returns by FY16. On average, the four FNArena brokers covering SPO are forecasting a dividend yield of 4.5% in FY15 and 5.2% in FY16, for what is basically a “staple” service business.
The consensus target now stands at $2.07 on a very narrow range from the brokers, suggesting 9.7% upside from current pricing.
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