I recently overhead two small business owners talking about what they would buy after the Federal Budget’s changes to accelerated depreciation rules. The first said he would buy new computer equipment, the second had his eye on a new work car.
Both joked about the generosity that gives small business owners, within limitations, an immediate tax deduction for the purchase of work-related assets below $20,000 – the ‘Tony’s tradies’ budget, as some commentators called it.
I’m not a fan of the change, mostly because it is too open to rorting, could encourage owners to buy assets they do not need, and because incentivising small businesses to pump-prime the economy through greater spending is not a sustainable way to boost the economy, particularly if the $20,000 is spent on non-productive assets.
But the change is good news for some retailers and credit providers to small and medium-size enterprises. The spike in radio advertising from retailers after the budget, targeting small business owners, shows they were quick to seize the opportunity.
Harvey Norman Holdings, an obvious winner from the change, looks fully valued. The car dealerships, Automotive Holdings Group and AP Eagers, should also benefit as more business owners upgrade their work vehicle or buy extra ones, below the $20,000 threshold. But they also look fully valued after strong gains in the past 12 months.
The credit provider, FlexiGroup, has had less attention. It provides consumer and commercial leasing, mobile and broadband, merchant payment and interest rate finance loans in stores. Products include FlexiRent, FlexiWay, and FlexiCommercial. Many a small business has bought products, such as laptops, using the popular FlexiRent service.
FlexiGroup has been a good long-term performer. Return on equity (ROE) has averaged above 20 per cent in the past five financial years, although is down from above 30 per cent in 2008 to 2010. ROE should remain above 20 per cent for the next three years, based on consensus analyst forecasts.
Strong growth in free cash flow since 2008 is a feature. Always look for small enterprises with surplus cash flow that can internally fund acquisitions and avoid those that always need large debt raisings or equity issuance that dilutes shareholders.
FlexiGroup’s earnings per share have edged higher in the past four financial years and there has been strong growth in dividends per share. A net debt-to-equity ratio of 266 per cent at the end of 2013-14 is too high and interest cover of 2.7 times is too low.
But the net debt-to-equity ratio is well down on five years ago and FlexiGroup has plenty of surplus cash and headroom in its lending facilities to maintain a high level of debt on the balance sheet.
The recent acquisition of New Zealand technology provider Telecom Rentals looks a good deal, but FlexiGroup would probably need a larger equity capital raising to support larger acquisitions as it continues it acquisitive-growth strategy.
FlexiGroup’s 9.1 per cent one-year total shareholder return (including dividends) is disappointing by its standards. Over three years, the annual return is 21 per cent and over five years it is almost 30 per cent. After hitting a 52-week low of $2.70, FlexiGroup has recovered to $3.56 but remains well down on prices above $4.50 in 2013.
Chart 1: FlexiGroup
Some headwinds for FlexiGroup are slowly easing. Business credit growth is showing signs of life, albeit off a low base, although it is far too soon to call a recovery. The Budget tax changes should give more impetus to business credit demand, particularly in the lead-up to June 30 as small businesses buy equipment.
Consumer confidence has also ticked higher since the Budget and May interest rate cut. This month’s Westpac-Melbourne Institute sentiment index had its first positive reading since February and the ANZ-Roy Morgan consumer confidence index is also higher.
That suggests consumers might start to spend more, slow their repayment of credit-card debt, or take on new finance. Nobody is holding their breath, but a gradual improvement in consumer and business confidence, still shaky to be sure, is a good sign.
FlexiGroup has shown it can grow by taking market share from rivals and that its in-store distribution channel and retail partners makes it less vulnerable to rampant bank competition in credit cards, although it is still affected by broader credit card trends.
The key issue, of course, is valuation. FlexiGroup trades on a forecast price-earnings multiple of 11.7 times 2014-15 forecast earnings, and just below 11 for the following year, consensus analyst estimates show. Seven brokers have a buy recommendation, two have a hold and one has an underperform. The median 12-month price target is $4.13.
Macquarie Equities Research has a target of $3.81 and an outperform recommendation. Morningstar has an accumulate recommendation and values the shares at $4.60.
There is enough to suggest FlexiGroup is undervalued at the current price, is cheaper than many of its peers, and that the market is underestimating its improving outlook.
Do not expect quick gains in next 12 months: sluggish business and consumer confidence will weigh on credit lenders such as FlexiGroup, and the Australian economy’s outlook will be challenged for some time. But FlexiGroup is an interesting idea for long-term investors who are comfortable with mid-cap stocks.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis at May 27, 2015.