McMillan Shakespeare Limited (MMS) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to half year results FY '21. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Mr. Mike Salisbury. Thank you. Please go ahead.

Thanks very much to Devina, and good morning, everyone. Welcome to our half year results presentation for financial year '21. My name is Mike Saulsbury, and I'm joined today by our Chief Financial Officer, Ashley Conn. As we flagged in our recent market update, the business has delivered underlying net profit of $42.7 million for the half, which includes a $7.3 million contribution from the JobKeeper subsidy. The underlying net profit result excludes adjustments for U.K. restructuring costs and U.K. asset impairments. Overall, the performance of the business has been pleasing, exceeding our initial expectations, buoyed by the rise in consumer confidence over the period and the favorable market conditions in the auto sector here in Australia. The improved economic conditions and the stronger operational performance gives us confidence to resume the payment of dividends with an interim dividend declared of $0.302 per share, fully franked. The pleasing performance is not just attributable to external factors. Our business has continued to demonstrate its strength. We've again proved our ability to flex when required. We've redesigned processes, developed new technologies and introduced new and better ways to connect with our customers through the past year that are delivering positive outcomes. Some of these positives are highlighted on Slide 3. In addition to the stronger profit performance and the reinstatement of dividend payments we have extended and strengthened our balance sheet and significantly improved our cash position, with free cash flows in the half of $42.2 million. And whilst delivering an improved operating performance, we have also remained focused on executing on our key strategic priorities. We have delivered customer growth in salary packaging, novated leasing and plan management, whilst also seeing improvement in our aggregation and retail businesses. The asset management profitability in Australia and New Zealand was strong, leveraging the favorable remarketing conditions. In the half, we've completed the U.K. restructure, delivered improved returns through our lighter capital management. We are on track and on budget to deliver the warehouse facility and maintained our digital investment to enhance the customers' experience, improve productivity and support growth opportunities. In all, I believe we've managed the period extremely well. I'll now pass to Ashley to speak more broadly on the company's financial position.

Thanks, Mike, and good morning, everyone. Over the next few minutes, I'll be talking to the consolidated performance balance sheet, cash flow and existing funding. I'll also touch on the work we are doing to establish our funding warehouse. I will then hand back to Mike to speak in greater detail about the individual segment performance. I'd like to start on Page 8 that sets out, as Mike said, group UNPATA, which is underlying net profit after tax and amortization of $42.7 million. Which is an increase of 13.1% versus the prior corresponding period. This includes a $7.3 million contribution from JobKeeper. The statutory net profit after tax was $25.5 million, which was down 25% versus pcp. However, this was impacted by $17.2 million of acquisition-related and nonbusiness operational items, including impairments and restructure costs, the details of which are on Page 31. I'd like to take a moment to talk about that in detail now. Firstly, there was a $0.8 million relating to the amortization of intangibles from historic acquisitions. Next, other costs relating to the restructure of the U.K. These include cash expense of $1.8 million relating to the acquisition of the remaining 50% interest in Maxxia Limited. This acquisition cost was based on a historic incentive arrangement to retain prior management. There was also noncash expenses of $12.7 million, which include the impairment of Maxxia Limited, impairment of a JV subordinated loan and impairment of a deferred tax asset. In the U.K., also, there was $2 million -- a $2 million write-down of the carrying value of CLM, where the COVID lockdowns have had a greater impact than anticipated. Moving back to Slide 8. EBITDA increased $68.1 million, up 19.1% for the half. The improvement was due to the positive result in GRS and asset management in ANZ, which Mike will walk through in greater detail shortly. Basic earnings per share was $0.329, and underlying earnings per share was $0.552. As flagged at the AGM, the interim dividend has been reinstated. It is $0.302 per share, fully franked, which represents 66% of underlying UNPATA, excluding the $7.3 million contribution from JobKeeper. As Mike had flagged, free cash flow for the half was a strong $42.2 million, or 99% of UNPATA, and I will discuss this in more detail in a few moments. Group return on equity was 24.1%, and return on capital employed improved to 22.8%. Moving to the next slide, Slide 9. Slide 9 provides a breakdown of MMS' balance sheet as a group, and importantly, also split between the asset management segment in Australia, New Zealand and the U.K. and the aggregated position of our other businesses, GRF -- GRS, RFS and corporate. Overall, the balance sheet is in good shape. Total debt is $200 million, including lease liabilities and asset management's fleet funded debt, and has resulted in net debt-to-EBITDA of 0.8x and gearing of 25%. This compares to $288 million at June 30, 2020; pcp net debt-to-EBITDA of 2.5x; gearing of 51%. The group's interest times cover increased to 13.8x versus the bank covenant for 3x. Cash as at 31 December was $117.1 million, resulting in a net cash position of $95 million, excluding fleet funded debt. In asset management net debt is now $145 million, resulting in a gearing ratio of 61% of the written-down value of the fleet assets, materially below our 80% bank covenant. During the half, asset management debt was reduced by the partial sale of the fleet lease portfolio and the ongoing reduction of the portfolio as detailed in the cash flow summary slide. Equity increased $255 million, mainly due to the statutory NPAT of $25.5 million. Other minor adjustments relate to the cash flow hedge reserves, FX translation reserves and the U.K. and New Zealand operations that was $43,000, and also to share-based payments in LTIP, which had a net impact of $570,000. Slide 10. Moving to our funding, Page 10, outlines our facilities, their purpose, size, drawn and undrawn amounts and duration. Total interest-bearing debt as at 31 December 2020 was $180.1 million. And MMS has $150.7 million of additional capacity across our asset finance facilities. And as mentioned, we have $117.1 million in cash. In addition, I would like to highlight that in December, the U.K. borrowing facilities were refinanced extended and favorably repriced. It allowed us to structure the debt with most of the amortization to match the profile of the underlying lease portfolio. In addition, in January, we repaid the amortizing debt facility that was due to mature at the end of the month. We have diversity of our on- and off-balance sheet funding of operating lease portfolio through Australia's major banks with over 30% of the asset management ANZ portfolio off-balance sheet. And also MMS' committed debt facilities are supplemented by $123 million of uncommitted off-balance sheet residual value guarantees from a number of Australia's banks. Slide 11. On the topic of funding, I'd like to discuss Slide 11 and the funding warehouse we are currently putting in place, which is going to be an increasingly central element of our balance sheet. It is an important strategic initiative for the business as it will provide us with through-the-cycle funding capability, funding diversity and also provide price tension with our existing P&A funders to provide the best service and pricing to our customers. Overall, the project is on budget and on track to put the first volumes through by June 30, 2021. Through the course of FY '22 and beyond, there will be an -- we will increase the volume through the warehouse as we gained approval from our customers to add the warehouse as a financier. It's an exciting development for MMS. As flagged on prior earnings calls, moving volume to the warehouse will necessitate a change in revenue recognition for any leases funded through the warehouse structure. That event, the net interest margin or revenue for such leases will be recognized over the life of the lease rather than upfront, which is currently the case for external funders. Modeling conducted by the project team indicates revenue would reduce in years 1 and 2 of the program, but the reduction is expected to have washed through by year 3, providing an annuity income stream thereafter. Slide 12. Turning to the cash flow slide on Page 12, which is split into our 3 segments plus corporate and unallocated. The group generated free cash flow before fleet funding of $42.2 million compared to the UNPATA of $42.7 million. Depreciation and other noncash items amounted to $25.5 million for the period. Capital expenditure totaled $4.2 million. As mentioned, the free cash flow before fleet increase is about $42.2 million or 99% of our UNPATA. Fleet assets on our balance sheet declined by $37.2 million and earlier in the half, we received the proceeds from 2 lease portfolio sales, mostly in Australia, for $32.5 million in total. $3.5 million of additional funds were advanced to the U.K. JV prior to the acquisition; and $6 million net cash was acquired when the JV acquisition completed at the end of the year. Borrowings decreased by $84.5 million. Lease payments were $4 million, and $0.2 million was used to acquire treasury shares. Consequently, as a result of the sources and applications of funds during the period, group cash on hand has increased by $25.7 to $117.1 million. Now I'd like to hand back to Mike.

Thanks, very much, Ash. And turning to the specific segments and starting with GRS on Slide 15. As you can see, we've had revenue growth of $3 million on pcp and approximately $6 million on second half '20. This has been driven largely by the improved contribution from Plan Partners and the 1.7% growth in salary packaging customers and 1% growth in novated leasing. The 2.7% growth in revenue understates the performance when you consider that interest rate reductions have reduced our earnings on the float by a further $2.2 million compared to pcp. Excluding float income, revenues increased by 4.9%. Total segment FTE has increased on the prior period, reflecting the growth in Plan Partners and our previously stated commitment to retain our people. The cost base includes around $1.9 million of additional OpEx cost attributable to the reduced capitalization rate of staff working on digital and system projects that was flagged at the FY '20 full year presentation. Net profit after tax of $33.5 million includes the JobKeeper subsidy of approximately $6 million and the additional contribution from 100% ownership of Plan Partners. Looking to the outlook, and I'll refer you to Slide 17. In my introduction today, I said that our results had exceeded expectations, in part, because of the favorable market conditions in the auto sector here in Australia. There is no doubt that the pandemic has had an impact on how people are thinking around their own mobility. We've seen a significant shift away from public transport use in the past 12 months, and a sharp increase in the level of demand for vehicle ownership, both new and used. Couple this with the lower production output by OEMs and we have the supply challenges that many are talking about today. Consequently, order to delivery periods have increased, and the level of price discounting by retailers has reduced. This lack of supply of new cars has increased demand for used vehicles, reducing available stock and pushing prices to record levels. As you can see, while stock levels remained high in the first quarter, sales volumes were up 6% on the prior comparable period, whilst yields remained relatively consistent with the second half of FY '20, down 7%. When supply reduced in the second quarter, unit sales have dropped below pcp and yields have increased to 105%. When combined for the half, total sales are up 1% and the yields down by the same percentage. Importantly, the lack of supply has not reduced the demand. Our order rates remain higher than the same time last year, customers are simply having to wait longer for delivery. In the second half and in the opening 7 weeks, we continue to see the same patterns with lower sales volumes due to the production delays whilst average yields have been maintained at the higher levels experienced in November and December. These conditions, whilst favorable, are abnormal. And as flagged in our market update on the 29th of January, we believe that these conditions will normalize throughout the second half of the financial year as supplier returns to more traditional levels in the fourth quarter. If we can turn to Slide 19 and the Plan Partners' business. This is a significant growth opportunity for us, and the business continues to go from strength to strength. As I said at the full year, the activity levels, service delivery and performance have generally been unaffected by COVID and the team have done a great job in continuing to service a growing number of customers through what's been a challenging time for people with disabilities and for those caring for them. Plans under administration grew by 118% to $909 million. You can see from the chart that the number of plans issued with plan management continues to grow every quarter. As at December 31, 45% of all plans now include plan management, with the most recent December quarter in excess of 50%. Plan Partners' contribution to group profit was $2.8 million for the half, which includes an increased allocation of MMS corporate costs as a wholly owned subsidiary of the group. Turning now to asset management here in Australia and New Zealand on Slide 20. I mentioned at the full year that COVID had been particularly challenging for this sector and that our team had done a great job in reducing the impact of the disruption by renegotiating contract extensions and minimizing the number of early returns. Both these statements remain true for the first half of the financial year. Corporates reducing the size of their fleets or extending contracts for further periods is affecting the size and the age of the book, reducing most revenue streams. Notwithstanding these challenges, the segment delivered a 22% lift in profit to $7.2 million, driven by remarketing returns. The combination of new car supply shortages that I spoke to earlier and contract extensions can be seen in the graph on Slide 21 where remarketing sales volumes for the half were down 32% on the first half '20, whilst remarketing yields were far ahead of the same period as demand outstripped supply, up 193% for the half and an even more staggering 300% for quarter 2. Clearly, this is not sustainable. And as supply increases, we should see these returns normalize over the remainder of the calendar year. In the U.K., and I'm now on Slide 22. Clearly, the effects of COVID have been much more severe in the U.K. than we've experienced here in Australia. Government-supported loans have assisted the asset finance sector and created the impetus for a stronger half from our asset broking businesses. The environment for fleet management and our CLM business has been more impacted. Like Australia and New Zealand, there's been a lack of supply of new assets and an increase in contract extensions, which has, again, aged the fleet and reduced the overall written-down value and associated revenues. In the U.K., we've also seen a higher rate of support required for customers due to the extended and wider-reaching lockdowns. These restrictions have directly impacted the number of returned assets and the ability to dispose of these assets via traditional channels. Consequently, we have an increase in the number of assets held for sale and a direct impact to expected revenues in the half. With the commencement of the vaccine rollout and lower daily case numbers, we anticipate conditions to slowly improve through the rest of the calendar year and a return to more normal trading in FY '22. I mentioned earlier that one of the highlights in the half was the successful execution of the U.K. restructure, and we provided more detail on this on Slide 24. As a reminder to all, our focus in the U.K. has been on 4 key objectives: to restructure the leadership in corporate office functions, to deliver on our cost-out program, to drive organic growth from our broking businesses and to accelerate the transition to a capital-light model. I'm pleased to say that much of the heavy lifting has been done. As you can see, the management structure has been completed, and we finalized the acquisition of the remaining 50% share of the Maxxia JV. One-off restructure costs of $14.5 million have been excluded from UNPATA, including a $1.8 million cash adjustment relating to U.K. long-term retention arrangements. Good progress has been made in rightsizing the cost base with a significant reduction in the size of our overall workforce. Despite the ongoing challenges, the asset broker businesses have returned to growth in finance originations, with off-balance sheet originations increasing by 18% on pcp and importantly, up 38% on second half '20. In line with our capital-light approach, 100% of these originations were written through P&A facilities and none through our balance sheet, whilst at the same time, the existing on-balance sheet value has been reduced by 51% to $66 million. In our RFS segment, both businesses are closely tied to the performance of the general car market, with the overall softer year-on-year performance impacting on our revenues and profits. However, there has certainly been signs of improvement in the half. As you can see on Slide 25, aggregation finance originations were $453 million and whilst down on pcp, we have seen a 6% improvement on the second half of '20, which is a positive sign, and we should continue to see this grow as vehicle stock volumes increase. It's a similar story for the retail business with an expectation that unit sales will increase as supply returns to the second-hand car market. Given the significant work done by the business in repositioning our products and pricing in recent years, it's encouraging to see the return of profitability in the period, albeit small. As you know, there's been a significant uncertainty surrounding this sector, which is still ongoing, and we expect to better understand the future landscape in the coming months. Lastly, and as per our market announcement on the 8th of February this year, we're pleased to confirm that the class action settlement was approved by the Federal Court. In summary, and on Slide 28. The performance in the half has been encouraging, with activity levels returning to more normal levels across most business segments. It demonstrates how capable our people are and how committed they are to our customers. Despite the challenges, we have stayed focused on what is most important, and we've executed well. We've delivered a solid operating performance and grown our customers in salary packaging, novated leasing and plan management. We've strengthened our balance sheet, and we've improved our cash position. And we're executing on our strategic priorities in restructuring the U.K., the continued investment in digital transformation and on delivering the funding warehouse. As we have discussed in some detail today, we've benefited from the abnormal conditions in the auto segment. And we expect these conditions to normalize over the coming months. And our performance in the second half to be consistent with the first half operating results net of JobKeeper. I'll now hand back to you, Devina, for any questions.

[Operator Instructions] Our first question comes from the line of Paul Buys from Crédit Suisse.

First question, just in relation to your comments, I guess, about benefiting from an abnormal environment. I was just keen to get your thoughts, I guess, on the interplay between yields and volumes, both with respect to GRS and in novated leasing as well as asset management. And I guess I'm trying to understand, would you rather have an environment where you're kind of benefiting from yields as you are now, but with the lower volumes? Or would you rather see volume normality and accepted yields go back down a bit?

It's certainly in the remarketing sense, Paul, the 300% returns on those assets gives you a much better return than returning to normal. In respect to the novated, we would clearly like to see unit sales growing on pcp. So our preference would be to see a normalization and for customers to be able to receive the new assets in a much shorter time frame than the order delivery periods that we're experiencing currently.

Got it. And on the novated then, with the yields, and I guess a little bit of a sort of a crystal ball question. But as you think about supply normalizing, do you think that that takes you straight back to kind of discounting levels that you were in the past? Or do you feel it's going to be a better balanced industry? And I guess, what I'm asking is even with volumes coming back, is there scope for some of those prices still to be a bit better than they were, say, a year or 2 ago?

I guess that's a question for others. We don't set the price in the retail market. But I think the experience currently and the levels of demand, they should be thinking about the level of discounting that's occurred in the past, and there may be upside moving forward.

Okay. And then last one for me, please. Just on the regulatory environment. And just with a view to some of the stuff that looks like went through in December relating to the deferred sales model for auto insurance, just wondering if you have any comments as to the road ahead there?

Well, the novated business will fall under the Treasury legislation that's consistent with the approach that [ NASPO ], on behalf of the industry, has been representing us on, I think, the position that Treasury has taken is very similar to the expectation of [ NASPO ]. So we're very comfortable where that's landed. In regards to the retail business and the warranty operations specifically, they're not captured under the Treasury, they'll be captured by the ASIC piece and that engagement with the market is still ongoing. So we're yet to fully understand where that's going to land. So it's a bit harder for us to fully understand what the position is going to be moving forward. But we do expect that that consultation and ASIC's position should be resolved within the coming 4 to 8 weeks.

Our next question comes from the line of Tim Lawson from Macquarie.

Two kind of questions just for clarity, really. I think, Mike, did you say that corporate is reducing fleet size, I'm not sure I caught that correctly, but also just if that is right? Is that just supply? Or are you thinking that's a planned reduction?

I think there's not the same bounce in business confidence as we've seen in the consumer side from a novator perspective so some assets haven't been replaced when they've come up for end of lease. We've also, through our own decision, ceased continuing to service a relatively large client during the during the period, which has reduced the size of our fleet. And that was purely in regards to their credit position and our appetite for risk. And the aging of the fleet is really that there isn't stock available now to replace these assets on mass. So we are seeing lease extensions push out waiting for supply to return to the market.

Yes. And just one clarification on the regulation comments you made. So how much product is impacted by that ASIC outcome to this view?

It only impacts on the RFS segment. As you can see in the half, the retail component of the RFS business delivered a $300,000 profit result, which we're pleased that it returned to profitability, but it's a very small overall contribution to the group.

Our next question comes from the line of Scott Hudson from MST.

Mike, I was wondering if you could maybe talk to the novated order book. And I guess, maybe are people signing up to leases and just sort of waiting for delivery? Or are sales being, I guess, deferred and existing leases put into sort of inertia while customers wait for supply conditions to improve?