Small Caps | Aug 15 2018
This story features SG FLEET GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: SGF
SG Fleet hopes to drive growth by increasing product offerings and acquisitions are firmly in its sights.
-Cross-selling services and end-of-lease income supporting FY19 outlook
-Organic growth slowing
-Acquisition synergies and returns need to be convincing
By Eva Brocklehurst
Value additions are in the headlights of SG Fleet ((SGF)), the corporate and consumer vehicle leasing enterprise, as the company's product mix shifts to higher-margin services. The company has observed that businesses are willing to pay for additional products, although the domestic consumer is more reluctant to commit to meaningful financial obligations.
SG Fleet hopes to drive growth by increasing the number of products and services per customer. FY18 revenue grew 7.9% and profit 8.0%, while fleet growth was a subdued 0.9%.
Morgan Stanley was disappointed with the revenue outcome, as sales growth decelerated sharply in the second half. The mix has shifted to higher-margin services, so margin is expanding amid flatter revenue. The fleet grew 1% while revenue grew 8%. The broker expects a similar profile in FY19, supplemented by end-of-lease income and cross selling services into the installed base.
The contribution from rental income was also higher, Macquarie observes, up 24%, with growth in on-balance-sheet vehicles and short-term rentals. Funding commissions declined as tighter margins on retail vehicles were only partly offset by an improvement in corporate margins.
Macquarie increases its previous valuation discount for the stock, despite making few changes to earnings estimates. This is because the composition of growth is increasingly reliant on revenue from additional products and services. End-of-lease income and cost efficiencies have largely countered modest growth in the fleet.
Citi observes, characteristically, SG Fleet did not provide guidance but expects to strengthen its competitive position as new services are adopted. The broker considers the stock undervalued and upgrades to Buy from Neutral.
Modest organic growth is expected to be supplemented by the increased penetration of clients via services. Citi also increases its discount, moving to a -25% discount to the Small Industrials from -15% previously. The broker believes the greater discount is warranted in order to reflect a lower growth profile versus peers. Margin expansion is also removed from long-term assumptions to imbue forecasts with more conservative numbers.
Citi estimates the company exhibited organic growth of 3.3% and acquisitive growth of 4.7% in FY18. The most recent acquisition was over 12 months ago. The broker lowers FY19 organic growth forecasts to 3.5% from 4.3% and assumes some marginal incremental headwinds.
Given increased regulatory scrutiny in the automotive sector the broker cannot rule out the downside risk to margins, particularly on finance commissions, but it appears the majority of the impact has washed through the industry.
Morgan Stanley also believes acquisitions are clearly on the agenda. Management has alluded to the inevitability of industry consolidation with reference to both Australia and the UK. Still, the share price is below levels where it traded following the NLC deal in November 2015.
In order to become comfortable about any initiative, Morgan Stanley needs to be convinced not just of the accretion but of ongoing synergies and the likelihood of a higher incremental return. Outside of compelling M&A there are few catalysts for the stock, so the broker maintains an Equal-weight rating.
Citi noticed the rhetoric on M&A is becoming stronger and that the company expects a transaction sooner rather than later in FY19. The broker suggests the company may have a number of targets in mind and speculates regarding a combination of SG Fleet and EclipX ((ECX)).
SG Fleet could participate in both corporate fleet leasing and novated leasing in Australia, and Citi points out, in corporate leasing, the top five players are tightly grouped from a market share perspective and, should any of these, hypothetically, ever be for sale, the scale for the acquirer could be material.
On the other hand, there are limited novated leasing businesses with scale available, following recent industry consolidation, although novated salary packaging opportunities remain. The broker concedes there is no consensus on SG Fleet's target but emphasises there is agreement on one topic: that scale matters in corporate automotive leasing.
The company has largely integrated its UK acquisitions and can return its focus to M&A in that region, Citi notes. The broker estimates SG Fleet could fully fund via debt a $150m acquisition before leverage hits 1.5x. The company has also mentioned that its majority shareholder, Super Group, supports both its organic and acquisition strategies.
FNArena's database shows two Buy ratings and one Hold (Morgan Stanley). The consensus target is $3.87, suggesting 11.8% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 5.6% and 6.0% respectively.
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