Five months ago (March 2023) I posted a straw on Smart Group titled “Cash Cow Struggling to Grow”. Smart Group was trading at around $6.00 at that time. Five months before that, in October 2022, Smart Group traded as low as $4.66. This followed the loss of the Department of Education and Training Victoria contract.

At that time Smart Group was struggling to grow earnings due to delays in the supply of vehicles for its salary packaging business, a setback from COVID 19.

At the time Smart Group had accumulated a lot of cash and franking credits. Management could not find opportunities to reinvest the cash so the board chose to return cash to shareholders as a special fully franked dividend (11% grossed up for the year) ROE was high at 25% but lack of growth saw investors dump the stock after receiving the special dividends.

At the time I valued the business at $6.16 based on a 12% annual return and could see only limited opportunity for growth.

Moving on to July 2023 and Smart Group has won a few contracts, growth has picked up, and the business is back to reinvesting 30% of its earnings. It is now trading at c. $8 per share, up 74% from its 12 month lows.

Returning to earnings reinvestment and growth has increased its valuation. From here analysts are expecting Smart Group to grow earnings at 7% per year and ROE is expected to exceed 26% over the next 3 years.

At the current share price ($8.04) Smart Group should return investors c. 10% per year including the franking credits (using McNivens StockVal formula). Dividends going forward are expected to be c. 5.7% fully franked. I’m pleased I held the shares while the business recovered from the COVID setback. Patience pays off sometimes.

Disc: Held IRL 4.2%

Today SmartGroup (SIQ) released its FY22 results. The market is ecstatic! The share price was up 8% at the time of writing. I must admit I’m pleased to see the share price up too with Smartgroup making up 3% of my portfolio IRL.

The market is excited because Smartgroup just declared a fully franked dividend (ordinary + special) of 29 cps for 2H, bringing the total FY22 dividend to 46 cps. That is a whopping 7.7% fully franked dividend, or 11% grossed up yield for the year based on a share price of $6.

Not bad you say? The problem is, that is all you are likely to get. Your total return. It’s still not bad and I’m certainly not complaining about it. There was certainly an opportunity to add some additional share growth after Smartgroup announced the loss of the contract with Department of Education and Training Victoria in October 2022 when it traded as low as $4.62. A big risk though back then!

Remarkably the business has managed to offset this loss with salary packaging growth from new and existing clients, bringing revenues back to FY21, plus 1%. If they can do this, perhaps they can win more new customers going forward.

The dividends are sustainable because of the NPATA of $61 million, which was slightly ahead of guidance. That’s about 46.9 cps. The problem is Smartgroup will pay out 98% of this as dividends. That’s what I call a CASH COW!

Whats wrong with that? The internal rate of return for Smartgroup is 23% (ROE). This has been steady for about 8 years. Over this period Smartgroup have also paid out almost their entire earnings as dividends, and surprise, surprise the earnings haven’t grown in 5 years.

Source: Commsec

What is this saying about the business? While the ROE is very good, the business can’t find opportunities to reinvest earnings for growth. If it could, it would. It tells me the market it operates in is almost saturated.

There are also risks in the industry. If the federal government rolled back on tax benefits through salary sacrificing, this would knock the wind out of the sails for the likes of Smartgroup, McMillan Shakespeare and SG Fleet.

I’m going to continue holding Smartgroup though. They have been concentrating on building smarts into the salary sacrificing platform, and when the vehicle supply chain starts to improve, there might be an opportunity for further growth in the future. I’m hoping they will start to win customers with a smarter, more user friendly platform.

The outgoing Smartgroup CEO Tim Looi said “Our business has proven to be resilient and has maintained steady operational performance despite the challenging economic environment and the ongoing supply chain disruption for new vehicles.”

“With vehicle orders continuing to exceed settlements, the company is well positioned to benefit upon the easing of new vehicle supply constraints. When this occurs we will realise the excess new vehicle order pipeline of c.$15 million as well as reduce the operating costs associated with maintaining this excess pipeline. Together with the introduction of the Federal Government Electric Car Discount Policy and the associated growth in electric vehicle leasing, Smartgroup is well placed for future growth”

Valuation

Using McNiven’s StockVal formula and assuming forward ROE of 23%, 98% of earnings paid out as dividends, 100% franking, and a required return of 15%, I get a valuation of $4.90. If you were happy with a 12% required return you could pay up to $6.16 which is about where it is trading today. For me it is a hold at the current price. If it goes much higher I will consider reducing.

Disc: Held IRL (3%)

It looks like private equity might be back kicking tyres at SmartGroup again. Last year the SmartGroup Board knocked back a bid of $9.25 per share. Now it is trading at an absolute bargain price of $4.80. Big mistake!…HUGE! (my favourite quote from “Pretty Woman”). I will be definitely keeping an eye on the share price today.

Last night (9.35pm, 1 December, 2022) the AFR published an article titled “PE takes another look about Smartgroup, board the battle”. I’ve copied part of the article below:

The private equiteers are back out for salary packaging, novated leasing and fleet management play Smartgroup, assessing whether it would be possible to pounce after a poor year and snap up the business for less than $1 billion.

Only 13-months after Smartgroup’s brief and unsuccessful fling with a PE suitor, buyout shops and credit funds have re-opened their files to try to work out what’s gone wrong and how easy it could be to turn performance around.

This time US private equity firm TPG Capital’s understood to be on the sidelines, leaving it to its rivals to think about getting serious about Smartgroup and putting the company in play.

The biggest and likely untested question is at what levels Smartgroup’s board and shareholders would be willing to sell the company.

The board was happy to engage at $10.35 a share last year, but cut off talks with TPG and its bid partner Potentia Capital when it returned at $9.25 a few weeks later.

Disc: Held IRL

Smartgroup had a good result for the half, but has it met analyst expectations? According to S&P Global data, the average of 6 analysts forecasts for FY22 (December) is over $65 million NPAT. The H1 22 result is $31 million, which is less than analyst expectations.

In addition, Smartgroup will lose the Department of Education and Training Victoria as a client later in the year. Smartgroup will onboard a number of new clients, including one client with c. 6,000 salary packages later in the year, buy will they drum up enough business to offset the DET Victoria contract? Possibly not.

However, Smartgroup remains a highly profitable, high margin, cash generative business with high ROE. It pays good fully franked dividends in excess of 5% fully franked, and this year has paid out about 10% fully franked to return some excess cash back to shareholders.

I think the share price will weaken today due to the bottom line being less than expected, but I like SmartGroup and will continue to hold it as a reliable dividend stock.

Held IRL (3%)

Smartgroup delivers increased revenue and a strong EBITDA margin; continues to invest in future growth

Smartgroup Corporation Ltd (ASX: SIQ) (“Smartgroup” or “the Company”), a leading specialist employee management services provider, today reported its half year results for the period ended 30 June 2022 (H1 2022).

• Revenue of $113.6m up 4% vs pcp

• Operating EBITDA of $49.4m in line with pcp

• NPAT of $30.9m up 16% vs pcp

• NPATA1 of $32.4m down 4% vs pcp, in line with lower acquired asset amortisation add-backs

• Adjusted after-tax operating cashflows at 134% of NPATA and net debt at $26.0m

• Fully franked interim ordinary dividend of 17.0cps

Smartgroup has again been able to deliver a strong EBITDA margin, at 43% for the half year.

Sound operating performance

Smartgroup CEO Tim Looi said: “We have been able to deliver a good financial result for the half year, despite lengthening vehicle delivery timeframes and we continue to have success in increasing our level of engagement with potential customers via both digital and non-digital channels.”

Smartgroup recorded organic growth of approximately 5,500 salary packages for the half year, and now serve a total of 383,000 customers across Australia.

Vehicle supply disruptions continued to lengthen sales lead times, with the excess pipeline of future settlements increasing to around $14m, from $12m at 31 December 2021. Importantly, despite these supply constraints, leasing settlement volumes and novated leasing yield were up 1% and 5% on pcp, respectively. As a result of supply issues, novated leases under management and managed fleet vehicles were down slightly to 62,800 and 24,850 respectively.

Leasing leads were up 6% on pcp and 15% on the previous half, demonstrating the success of new digital assets, such as the updated Smartleasing novated leasing calculator. However, lower consumer confidence, driven by rising interest rates and inflationary pressures on households, and extended vehicle delays have led to potential customers delaying buying decisions. This has resulted in vehicle order levels being in line with the previous half and 7% down on pcp.

Smart Future

The Smart Future program was launched in May 2021 to drive future earnings growth through investment in three key strategic priorities – optimising customer experience, enhancing digital platforms and streamlining operations.

During the half year to June 2022, we progressed the build phase of several key digital assets, with the new Smartsalary website launched in late July and Phase 1 of the Vehicle Sales Portal to be launched later in 2022. These digital assets will deliver superior user experience, improved self- education and will enable customers to engage with Smartgroup digitally, at any time of day.

Outlook

Smartgroup CEO Tim Looi said “We are in good shape operationally and I am pleased with our results for the half year.

“Like all businesses in Australia, we are experiencing some wage inflation. It’s good to see the growth in vehicle leads as we roll out our digital assets, but the impact of interest rate rises on consumer confidence is leading to an extension to the timeframe for customers to proceed to a vehicle order.

“The second half of 2022 will see us onboard a number of new clients, including one client with c. 6,000 salary packages, partially offsetting the non-renewal of Department of Education and Training Victoria, whose transition out will occur later in the year.”

“Vehicle supply timeframes are continuing to extend and delay our settlement timeframes, resulting in a further increase in our pipeline of future settlements. While we face some short to medium term macro-economic and industry-wide headwinds, we have a resilient business model and our operational performance is strong, so any improvement in these external factors should have a positive impact on our business.”

SmartGroup announced it has lost the DET Victoria contract this morning (see previous straw)

The market is punishing SmartGroup, down 10% at time of writing. Is this justified?

SmartGroup said the contract loss will not materially impact CY22 earnings, and the impact on CY23 would be less than 5%.

Also within the announcement “Smartgroup advises that it currently expects H1 2022 revenue and EBITDA to be in line with H1 2021”

This is more likely to be the reason why there is severe pressure on the share price today.

Looking at the earnings forecasts on Commsec, analysts were expecting CY22 earnings to be circa 54cps.

CY22 earnings were 47.2cps, and according to SmartGroup H1 2021 and H1 2022 are expected to be similar.

I expect H122 earnings are under some pressure due to the supply of cars for salary packaging, and it is unclear at this point if this will improve in H2.

Regardless, this does put pressure on SmartGroup to meet the analysts expectations of CY22 earnings of 54cps.

It will be interesting to value SmartGroup assuming flat CY22 earnings to see if the sell off is justified.

Lets assume CY22 earnings are 47cps (same as last year). Current shareholder equity is $2.05 per share. That gives us a forward ROE of 23%. Still very respectable.

Using McNiven’s StockVal formula and requiring a return of 10%, and assuming 80% of earnings will be reinvested to grow earnings:

V = (23/10 x 0.2 x 23% + 0.8 x 23%) /10 x $2.05

= $5.94

This valuation excludes dividend franking credits. 80% of SmartGroup’s earnings are paid out as earnings so the franking credits are substantial.

Making adjustments for franking credits, and assuming SmartGroup’s earnings will be flat this year I think $6.50 is fair value.

For me it’s a HOLD, and there could be some potential on the upside if SmartGroup win some new contracts.

Disc: Held IRL

The news is not so good for Smart Group holders this morning with Smart Group losing the DET Victoria contract. This is not expected to impact CY22 earnings. The DET Victoria contract is expected to be less than 5% impact on CY23 earnings. I like this businesses. I hope they pick up a few wins somewhere else.

Disc: held IRL

Department of Education and Training Victoria - contract update

Smartgroup Corporation Limited (ASX:SIQ, Smartgroup or the company) advises that following the completion of a competitive tender process, the Department of Education and Training Victoria (DET Victoria) has advised that it will not be renewing its contract with Smartgroup.

DET Victoria has been a long-term top 20 client of Smartgroup. Smartgroup is proud to have provided its services to DET Victoria over this period.

The contract transition date and terms have not been settled. Smartgroup does not expect a material impact on revenue in CY2022 as a result of the loss of this contract and expects an impact of less than 5% of revenue in CY2023.

Smartgroup advises that it currently expects H1 2022 revenue and EBITDA to be in line with H1 2021.

Smartgroup Chief Executive Officer, Tim Looi said, “We are of course disappointed that Smartgroup was not selected to continue our relationship with DET Victoria, however we have many strong long- term relationships with our diversified client base and continue to focus on customer experience as a key driver of those relationships.

“In 2021, we renewed or extended all top 20 contracts that fell due and we have now renewed or extended the majority of the top 20 contracts that fall due in 2022, with only one still remaining for renewal later in 2022.”

This announcement was authorised by the Board of Smartgroup for release to the ASX.

Smart Group’s released its presentation Macquarie Australia Conference and business update this morning (to be presented today).

Smart Group is not a businesses that will shoot the lights out from one report to the next, however, since its IPO in 2014 it has returned investors >700%, including franking credits. I think it’s a steady consistent cash cow to have in your portfolio with high ROE (30%) and low debt/equity (10%). It has also been one of the few businesses whose share price has defied gravity over the past 3 months.

Business update to 30 April 2022

 Salary packaging customers are up c.5,000 since 31 December 2021, +1% growth

 Year to date novated leasing leads are up 6% versus the prior comparable period (pcp)

 Excess vehicle order pipeline revenue now at c.$14 million, up from c.$12 million at 31 December 20211

 Transition of novated funding from St George to Angle Auto Finance successfully completed and further automation within the existing funding panel also completed

 Revenue and EBITDA in line with our expectations and pcp

 Low net debt position of $47m and leverage of 0.5x EBITDA Smartgroup CEO Tim Looi said:

“We are pleased with the start to 2022. In the four months to 30 April 2022, Smartgroup has seen good growth in salary package numbers and achieved continued growth in novated leasing lead volumes.

Vehicle settlement timeframes continue to be extended due to ongoing global vehicle supply shortages. Consequently, our vehicle order pipeline has continued to grow and now represents an additional $14 million of future revenue, above pre-COVID levels. In terms of financial results, revenue and EBITDA are in line with our expectations and in line with the prior corresponding period.”

Outlook

Smartgroup CEO Tim Looi said: “We have made good progress so far in 2022 and look forward to building on our Smart Future program momentum, which is targeted to generate sustainable EBITDA growth through both revenue expansion and operational efficiencies.”

Disc: Held IRL

I’ve held Smart Group for a number of years. I think it is a quality business that pays an excellent dividend and more recently has been spewing cash!

I added substantially to my holding just prior to going ex-dividend on the 8th March 2022. Including the one-off special dividend SIQ paid out 49c fully franked, or 70c including the franking credits (100%). For the FY22 year SIQ paid out 66.5c fully franked, or 95c including credits. That’s equal to a grossed up yield of over 11% including the tax credits based on an $8.50 share price. Not a bad cash cow! :) But is it a dividend trap?

Smart Group (SIQ) provides outsourced administration, primarily salary packaging, software, distribution and group services (SDGS) and fleet management services to employees of State and Federal Government departments, Public Benevolent Institutes and corporate employers. SIQ operates mainly in three segments: Outsourced administration, Vehicle services and Software, distribution and group services (Commsec summary).

Smart Group has two main competitors, SG Fleet (SGF) and McMillan Shakespeare (MMS). All 3 companies have been growing by organic growth and acquisitions. I believe there is little opportunity of further acquisitions for Smart Group, and free cash flow and tax credits have been accumulating.

Fundamentals

Smart Group has more than doubled earnings in 6 years, and has averaged an ROE of approx 20% for several years (see CommSec graphs below).

Gross Margin is 61% and Net Profit Margin is 27% (Simply Wall Street).

Smart Group pays out 80% of its earnings in dividends and reinvests 20% back into the business. According to 6 Analyst Estimates (S&P Global) forecast earnings growth is 9.5% per year until 2024.

Valuation

Working on average forecast FY24 earnings of 61c and a PE of 17 (approx average over past 4 years) and discounting at 10% per year, I estimate the current valuation for Smart Group as:

v = 17 x .61 x 0.7 = $7.26

Now this doesn’t account for any dividends payments over the next 2.5 years. As a consistent dividend payer, we could expect approx 50c fully franked per year. If we also discount 2.5 years of grossed up future dividends at 10% this would be equal to 2.5 x 70c x 0.8 = $1.40. (70c Including tax credits).

Adding the two values we get approx $8.60 which is close to where Smart Group is currently trading. Therefore, at a current share price of $8.60 it is possible that Smart Group could return investors an average 10% per year until 2024. Smart Group is not going to shoot the lights out, but for me it’s a HOLD as a cash cow for the next few years. The current share price momentum is also looking good.

Key Risk

Government policy in regards to salary sacrificing and fringe benefits tax remains a key risk for SIQ, SGF and MMS. The values of these businesses could plummet if the employee tax benefits were scrapped, as has been threatened in the past.

History

Hi @Seeker68,

I also hold Smart Group IRL and pleased with the proposal. It is important to consider that this is a 'Non-binding indicative proposal' so it is not yet a done deal!

'The Proposal remains subject to several conditions, including:

1. completion of due diligence to the Consortium’s satisfaction
2. final approval of the Board of Smartgroup and the investment review committees of each of TPG Global, LLC. and Potentia Capital; and
3. the negotiation and agreement of the terms of an implementation agreement customary for a transaction of this nature.'

There is some risk the proposal won't proceed, however I would consider this to be a low risk.

The other thing to consider is the tax implications. If you wait for the proposal to proceed you will be eligible for tax credits on any dividends received in the interim. If dividends are received they will be deducted from the offer price of $10.35 per share.

If the proposal falls through, over time the price is likely to gravitate back to where it was prior to the proposal.

Yesterday SIQ closed at $9.28 per share. At that price I will be holding on to my shares. However, if they reach $10.20 per share while the proposal is under consideration I will be taking the money and investing elsewhwere.

I hope this helps.

Rick

Announcement

Smartgroup, a leading specialist employee management services provider, today reported its half year results for the period ended 30 June 2021 (H1 2021).

My take:

Projecting the current growth forward for the full year puts Smartgroup earnings in line with analyst expectations. A very strong EBITDA margin of 45% should go down well with  investors today. Also targeting an additional annualised EBITDA uplift (above system growth) of $15-20 million in 2024 through Smart Future strategy.

Highlights:

• Revenue of $109.4m up 4% vs H2 2020, and down just under 2% vs pcp1
• NPATA2 of $33.5m up 1% vs H2 2020, and up 5% vs H1 2020
• Adjusted after-tax operating cashflows at 107% of NPATA2 and net debt at $4.5m
• Fully franked interim ordinary dividend of 17.5cps3
• Disciplined cost management has led to a strong EBITDA margin of 45% for the half year.

Smartgroup CEO Tim Looi said: “We have seen good momentum from improved business conditions, including success in winning new clients and renewing existing key client contracts. In particular, our strong renewal rate is a testament to the hard work of our team, the service we offer our clients and the loyal relationships we foster.”

The Company recorded strong organic growth of approximately 13,000 additional salary packaging customers during H1 2021 and now manages a total 373,500 packages. This was achieved despite client on-site sales activities being restricted due to COVID-19 outbreaks. Approximately 8,500 of these packages were introduced from a new health sector client onboarded in April this year. Pleasingly, Smartgroup had a 100% success rate renewing or extending all of the top 20 contracts falling due this calendar year. Importantly our largest client, Department of Defence, which has been with Smartgroup since 1999, renewed for five years, inclusive of extensions.

New lease vehicle orders increased to pre-COVID levels in Q2 this year. However, vehicle supply disruptions have resulted in longer lead times, building a pipeline of future settlements. Despite supply constraints, leasing settlement volumes were up 2% on pcp and 4% on H2 2020. As a result of these supply issues, novated leases under management were down slightly to 65,600 and managed fleet vehicles grew modestly to 25,100.

Smart Future
As outlined in our business update in May, Smartgroup is driving future earnings growth and delivering a Smart Future for its employees, clients and customers, underpinning solid growth in returns for its shareholders. Smartgroup is targeting a sustainable additional annualised EBITDA uplift (above system growth) of $15-20 million in 2024.

The three key strategic priorities of the Smart Future program are optimising customer experience, enhancing digital platforms and streamlining operations. This includes, amongst other projects, redesigning client and customer portals, migrating to cloud infrastructure and software, investing in business automation and enhancing data analytics capability. The program will take three years to deliver, with an estimated spend of $5-$6 million per annum, which will be funded from the Company’s balance sheet facilities.

The client transition program that commenced more than 2 years ago is progressing well, with c.1,800 employer clients and c.90,000 employee customers moving from legacy brands and platforms. The transition of Advantage clients to the Smartsalary and AccessPay brands is expected to complete next year and will result in an estimated $2 million per annum reduction in operating expenses, to partially offset the Smart Future investment.

Outlook
Smartgroup CEO Tim Looi said “I am pleased with how we performed in the first half of the year and also positive about the future growth of Smartgroup, underpinned by the Smart Future.
“While the current economic disruption brought on by the COVID-19 pandemic is likely to negatively impact vehicle orders, Smartgroup’s business is in good shape operationally and we are well positioned for recovery and continued growth in orders when lockdowns ease.”

Smartgroup continues to generate high quality earnings from a diversified and loyal client base operating in defensive sectors. The Company’s customer focused culture underpins a high client retention rate and Net Promotor Score and our continued focus on client service and our investment in people, processes and technology are delivering positive results.

Disc: Held IRL