Unpacking The Salary Packaging Sector

Australia | Dec 14 2022

A review of recent broker research on salary packing companies, following new coverage by Citi for McMillan Shakespeare and Smartgroup Corp.

-Citi initiates coverage with Buy ratings for McMillan Shakespeare and Smartgroup
-McMillan is preferred for greater diversification and NDIS-related growth
-Both companies should benefit from electric car discount legislation
-Current share prices imply material upside to broker targets
-Additional ASX-listed salary packaging companies

By Mark Woodruff

For investors seeking relative earnings safety on the ASX in the face of macroeconomic headwinds, Citi recommends leading salary packaging providers McMillan Shakespeare ((MMS) and Smartgroup Corp ((SIQ)).

The broker initiates coverage with a Buy rating for both companies that each have a defensive customer base in industries such as healthcare, public administration, education and defence.

The National Skills Commission expects key industries in the salary packaging industry in Australia will grow by around 6.4% to 15.8% between 2021-2026.

McMillan is a provider of salary packaging services (including novated leasing), disability plan management and support coordination, asset management and related financial products and services, with operations in Australia and the United Kingdom.

As well as providing employee benefits and workforce optimisation services, Smartgroup offers fleet management and software services and has risen to become the number one salary packaging provider and number two novated leasing provider in Australia.

Citi prefers McMillan Shakespeare over Smartgroupdue to its more diversified business model, with around 22% of revenue derived from novated leases,compared to 58% for Smartgroup.

Mind you, should new vehicle supply improve, Smartgroup is the more leveraged play, with a 10% increase in volume potentially adding $10m to earnings, according to the broker. Its felt consensus is underestimating novated leasing volumes for the company in FY23, and the operating leverage from volumes, which can help offset wage pressures.

Global original equipment manufacturer (OEM) production remains depressed, and given recent OEM and automotive semiconductor company commentary, current conditions are expected to persist. While the semiconductor companies see improved conditions, some products are still in short supply. Citi forecasts FY23 will be a relatively stagnant year for lease volumes before rebounding in FY24, when new car supply should start to improve.

The broker also likes McMillan Shakespeare for the growth potential of its Plan and Support Services (PSS) division.The company is the number two plan manager in Australia, with only 25,900 customers and an estimated market share of 8.6%.

National Disability Insurance Scheme (NDIS) participants are expected to grow at an around 6% compound annual growth rate (CAGR) out to FY30 and the highly fragmented plan management industry is thought to provide inorganic growth opportunities.

Citi envisages a large runway for the company to increase its customer base both organically and via acquisitions, with the plan management industry highly fragmented, with the top ten only accounting for 38% of market share.

Both McMillan Shakespeare and Smartgroup also have an opportunity for an expanded customer base, suggests Citi, due to the Federal governments Electric Car Discount Bill, which is set to be legislated following its approval in the Senate.

The Bill removes the fringe benefits tax on cars made available by employers to current employees that are zero or low emissions vehicles with a value at first retail sale below the luxury car tax threshold for fuel efficient vehicles ($84,916). Potential savings to corporate employees of $6,300-$13,100 per year are forecast by the broker, though potential uptake of the discount may be impacted by semiconductor shortages, which are constraining new car supply.

By setting a $16.40 target for McMillan Shakespeare, Citi raises the average target price in the FNArena database to $15.65 from $15.46, while the brokers $6.60 Smartgroup target lifts the average to $6.04 from $5.93.

These average target prices suggest 13.7% and 20.8% upside from the current share prices for McMillan Shakespeare and Smartgroup, respectively.

Additional ASX-listed salary packaging companies

Other companies in the ASX Salary Packaging sector include SG Fleet ((SGF)) and Eclipx Group ((ECX)) which both provide fleet management and leasing solutions.

While no earnings guidance was issued by SG Fleet in a late October first quarter trading update, Overweight-rated Morgan Stanley (target $3.40) pointed to strong tender activity with novated leads well ahead of expectations, though the UK was experiencing some tapering of activity.

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