McMillan Shakespeare Limited (MMS)
The Global Financial Crisis (or GFC as it is now popularly referred to) proved to be a harsh wake up call to many investors who were swept up in the euphoria of perpetually rising markets and an unlimited commodities boom. The lesson is clear – ignore sound fundamentals and prudent capital management practices at your peril.
Many companies banked against Newton’s Law of Gravity by kicking into stock markets and employing risky practices, such as gearing themselves to the hilt in order to take advantage of the many opportunities or paying overly inflated amounts for assets or other companies.
In the heyday of 2005-07, management that presided over what now many analysts and CEOs drool over – balance sheets with little to no debt and high levels of cash, were not rewarded for their prudence. Instead, they were accused of sitting on a lazy balance sheet, failing to take advantage of opportunities and exposing the company to a takeover.
There were companies however, that did not succumb to the lure of cheap debt, did not buckle to the pressure of chasing growth at any cost and kept their business simple and profitable. These companies are now beginning to reap the benefits of such action. McMillan Shakespeare Limited (ASX:MMS) is one such company.
About McMillan Shakespeare
Based in Melbourne and listed on the ASX in March 2004, MMS has two wholly owned subsidiaries, McMillan Shakespeare Australia Pty Ltd and Remuneration Services (Qld) Pty Ltd.
MMS is Australia’s leading provider of independent salary packaging services in Australia. The key salary packaging services include salary packaging benefit administration and processing, remuneration policy design, FBT, GST and BAS reporting and motor vehicle lease management. These services are aimed primarily at public service employees.
MMS and its competitors vie for mandates, generally from government departments, to supply their employees with their products. Once the mandate is awarded, MMS then sell their products to the respective employees in order to generate revenue. This is mostly done through educational seminars conducted on the work premises of the prospective clients.
MMS’s main competitor is SmartSalary Pty Ltd, a Sydney based company offering both salary packaging and delivery of tax management reporting. They run second to MMS in market share and have a similar client base.
How MMS’s Products Work
MMS’s main products include salary packaging, meal entertainment payment cards and novated leases. Their clients benefit from these products by increasing their disposable income through the payment of assets or additional superannuation contributions from gross rather than post-tax salary.
An example is provided below:
Brochure for employer is a Private Company, a Public School or a Government Department
To provide this service, MMS charges its clients a fee as determined by the salary packaging policy of the client’s employer. This fee is then deducted from the client’s salary packaging account each pay period.
The example above relates to salary sacrificing for a laptop, however MMS extends its offering to include other benefit items, such as additional superannuation contributions, motor vehicles and meals. To provide an illustration of how MMS actually make their money, we will use MMS’s novated car lease product. Aside from the standard flat fee that MMS generates from providing administration for the product, they also pocket a rebate from the respective car vendor and if insurance and other incidentals are added on, rebates on those as well. This structure applies to all the benefit items.
Employees of the public service get the greatest benefit from MMS’s products, as they are exempt from fringe benefits tax. Employees of private companies are not afforded this same luxury. While the above laptop example did not have FBT implications, the following example of a novated car lease highlights this point. Note however that employees of private companies still benefit from such a structure, just not to the same extent.
Brochure for Novated Lease
In addition to MMS’s core services, they provide complementary services including performance management system design, remuneration and reward system design and financial advisory referral service (http://www.mcms.com.au/aboutus/ourservices.asp).
As demonstrated in the above table by the Normalised Return on Equity (NROE), the performance of MMS has clearly been outstanding. NROE is a profitability ratio measuring the level of Normalised profit a company generates for every $1 of owner’s equity employed in the business.
The above table shows that historically, MMS has been generating extremely high levels of profitability, ranging between 45 to 55% and 47.0% on average for the past five years.
This is also depicted in the chart below.
It is not only the level of NROE that is impressive but the fact that MMS has been able to maintain this high level of Return on Equity for a sustained period of time. This is an incredibly hard feat to achieve, because the profit generated by the company must rise by the same percentage as the increase in equity.
Year after year, MMS has been growing their profit base and have done so exclusively through the use of retained earnings. Unlike many other companies, they have not needed to run to the debt or equity markets for additional financial resources to fund ongoing operations. What does this mean for shareholders? Put simply, the company does not dilute existing shareholders through equity raisings and does not increase the financial risk profile of the company through increased debt, both of which are positives for investors.
MMS also caters for those searching for attractive dividend yields, with the grossed up dividend yield coming in at 7.7% at the time of publication.
MMS Balance Sheet
As described in the introduction, MMS has a Balance Sheet that many companies are now attempting to replicate through capital raisings and debt reduction. With high levels of cash and no debt, this Balance Sheet underlies the overall attractiveness of MMS’s fundamentals.
Whilst it is noted that MMS has a high level of intangibles, which are all comprised of goodwill, even if this was to be written down to zero, the level of assets would still easily exceed liabilities by around $10.0m.
An Attractive Industry
The major risk to MMS is political risk, that is, the risk that the Australian government will amend respective tax legislation such that any benefits MMS currently provide through their product offering are legislated away. Given that the large bulk of beneficiaries from MMS’s products are Public Service employees, it would surely border on political suicide for any government to pursue a path down this road, so the risk of this is considered quite small.
Alternately, MMS is posed to become a main beneficiary from the GFC. After simultaneous global stimulus packages have left many governments from around the world of any persuasion reeling in debt, many of these, including our own, have begun to espouse the idea that going forward, sacrifices will need to be made by everyone to ensure that the debt burden is reduced once the economy picks up. This translates to government spending to be cut and taxes going up. It is this latter point that provides the opportunity for MMS. As income taxes increase, especially for the higher earners of the income spectrum, so should the demand for MMS’s salary sacrificing products.
McMillan Shakespeare Limited meets our criteria as a quality company. It has strong characteristics and the management has done a good job in holding the profitability of the company over the last five years.
This gives us confidence in the performance of the business going forward. The market has been interested in the stock recently with strong gains this past month. We think the stock is still a buy up to $3.50.
By Daniel Sciberras – StockVal Technical Manager
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