Smartgroup Corporation Ltd (SIQ) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Smartgroup Corporation Limited SIQ results release. [Operator Instructions] I would now like to hand the conference over to Mr. Tim Looi, CEO. Please go ahead.

Thank you, Rachel. Good morning, everyone, and thank you for joining us on the call today. So my name is Tim Looi, I'm the Managing Director and CEO of Smartgroup. And joining me on the call today is Anthony Dijanosic, our Chief Financial Officer. So Anthony and I will provide an overview of our financial performance for the half year to June, our key operational highlights and our progress on Smart Future, our program for organic growth. We'll comment on the current industry dynamics and then take your questions. But first of all, I would like to acknowledge the traditional owners of the land on which I'm speaking to you from today, the Gadigal people of the Eora Nation. As this event is being broadcasted nationally, I would also like to acknowledge the traditional custodians of the various lands on which you all joined this call from today. I recognize a continuing connection to land, waters and culture and pay my respects to their elders past, present and emerging. So now let's turn to the investor presentation. So our results for the 6 months of June 2022, reflects solid financial performance. So first, we delivered revenues for the half of $113.6 million, up 4% on the prior corresponding period. EBITDA of $49.4 million is in line and NPATA of $32.4 million was down 4% due to lower acquired asset amortization add-backs. Second, we continue to record strong leasing leads for half 1, with further growth in the new leased vehicle order pipeline. Third, our Smart Future program has delivered some key digital assets, despite some challenges in technology resourcing. And finally, our capital light business model, means we generate a strong level of free cash flows. Our after-tax operating cash flows were at 134% of NPATA, and we have a small net debt position. This continuing strong financial position has allowed us to declare an interim ordinary fully franked dividend of $0.17 per share. Now turning to Page 4; our operating EBITDA margin at 43% remained strong, and our interim dividend of $0.17 per share is at a payout ratio of 70% of NPATA. Then moving on to Page 5. We recorded a 5,500 increase in salary packages. Now with the constraint in car supply, our novated leasing carpark declined for the half. Now when car supply normalizes, we should return to growth in the car park. Now on Page 6, this shows the performance from novated leasing. So total leasing leads for half 1 continued to grow, with total leads up 6% on PCP, driven by an increase in digital leads of 8% -- plus 8% against what was a relatively strong prior period. Our order levels have continued to grow faster than deliveries, with the excess order pipeline at $14 million. The total pipeline of orders is now at $18 million. Our novated leasing yields have grown to 5% due to higher value vehicles being novated and stronger product uptakes. And as expected, with the constraints on the supply of new cars, new novated leases as a proportion of total leases are at only 74%, a lower level than the 78% to 80% recorded pre-COVID. Now new novated leases, when compared to refinances, generate higher margins through a higher-value vehicle, as well as higher catchment rates for additional products and insurances. While half 1 performance is pleasing, we are seeing lower consumer confidence impacting vehicle orders through delayed purchasing decisions. This can be seen in the decline in vehicle orders versus PCP of 7%. Now turning to Page 7, we have shown the timeframes for vehicle deliveries for Smartgroup's top 30 car models. Smartgroup's delivery time frame of around 90 days, is much longer than prior year and certainly pre-COVID. The lengthy and also changing delivery schedules have meant additional rework to our pipeline in the form of credit reapprovals and logistical work to reaffirm deliveries. While 90 days is an extension to historical deliveries, it is much shorter than what is available through many dealerships. Smartgroup's bulk procurement process for some maker models have been successful in offsetting the impact of the extension of delivery timeframes for those vehicles. Now turning to Page 8; we have recently relaunched the Smartgroup website by taking a phased approach over the next several months, where we're adding refresh tools focused on customer experience and self-education. So far, we have seen superior customer engagement through enhanced visitation data we're now getting. Longer term, it will drive greater awareness of benefits and easy engagement for online sign-ups. Now moving now to Page 9, we flagged a little while ago, our development of a digital self-serve tool, to engage customers for novated leasing. The vehicle sales portal will enable customers to self-serve 24 hours a day, 365 days a year. Phase 1 of this digital tool will be launched in half 2 on a trial basis with select clients. And turning to Page 10, since we've announced my future, we have delivered some good foundations for our business. What was delivered over the last 12 months will complement and improve our customer experience program. With each new asset, we'll be testing, measuring, making changes to ensure these tools improve our capabilities to drive the targeted outcomes. We also have the next set of priorities mapped out. Phase 1 of our vehicle sales portal and enhanced salary packaging calculators will be rolled out progressively. However, we are making some changes to how we are currently delivering the Smart Future program. Given the challenges we're seeing in technology resourcing and costs, we're revising the project scope to utilize more in-house resources and fewer external staff. This will extend the delivery timeframe, but it makes sense to now start developing this IP internally. Now turning to Page 11; with the change in the federal government, Labor has tabled proposed legislation to abolish the FBT on new electric vehicles through novated leasing arrangements. Now when passed, this legislation will increase the attractiveness of EVs, EV purchase through a novated lease. Now together with the savings from procurement, savings from GST and now an exemption from FBT, a novated lease or an EV is more attractive than ever. Smartgroup as one of the largest novated leasing providers, will be a beneficiary of this legislation, when EV supply improves. Now let me hand you over to Anthony, who will take you through the financial results.

Thank you, Tim. Turning to the profit and loss on Page 13. You will see that we have been able to grow revenue, despite continuing global vehicle supply issues and with some restrictions to on-site client sales activities still in place for much of the half. The increase in our novated lease settlement volumes and improvement in novated yields, both contributed to an increase in group revenue. Revenue for the half also includes $1.8 million of one-off items related to the successful transition of our primary novated lease funding providers from St. George to other financiers. The revenue booked excludes the $2 million increase in open vehicle orders, as we only record revenue on settlement of novated leases. Our open excess order pipeline now represents $14 million of future revenue, for which most costs have already been incurred. Our operating EBITDA margin remained strong at 43%. We have seen some cost inflation come through in the staff cost line, arising from a mid-2021 group-wide pay review and from increased market rates for new and replacement roles. There has been some inflation evident in the other overheads line as well. I also draw your attention to the amortization line and the add-backs below the net profit after tax line. These have reduced, as acquired intangible assets are now largely fully amortized, and we will see a significant reduction in those lines in half 2. Both of these lines will then be negligible in 2023. The reduction of $1.1 million in non-operational cash tax benefit add-backs, is the reason for the 4% reduction in NPATA, despite EBITDA being in line with PCP. Page 14 shows that we continue to generate a high level of operating cash. We successfully negotiated an upfront payment of future performance fees from St. George, on completion of the transition of novated funding to other financiers. Excluding this one-off payment, operating cash flow generation would have remained high at 99% of NPATA. We are now earning a modest amount of interest income on our client floats, and this amount will increase with any further RBA rate increases. $6.4 million of Smart Future costs were capitalized in the half with the new Smart Salary website, salary packaging calculator and vehicle sales portal projects, all being in delivery phase. We also continue to provide a small amount of on-balance sheet fleet funding, as a pilot for a handful of clients. Moving to the balance sheet on Page 15, you will see that we ended the half with a small net debt position. In March this year, we returned around $65 million to shareholders in the form of fully franked dividends, including just under $40 million in special dividends. The 2022 interim dividend declared, amounts to around $22.7 million to be paid in September. With that payment, we forecast our net debt position to remain very low, at less than 0.5x EBITDA. I'll now hand back to Tim.

Thank you, Anthony. And now if you turn to Page 17. And in summary, we're pleased to be able to report a solid set of financial results for the half year, despite the continuing vehicle supply issues. Our leads grew strongly in half 1, and our excess vehicle delivery pipeline is now at $14 million, total overall pipeline at [ $18 million ]. Now later this year, we will onboard a new client with over 6,000 packages, partially offsetting the transition out of Department of Education and Training Victoria, which will occur in Q4. And I am pleased with our progress on Smart Future, the latest developments will enhance our capabilities to improve customer experience, digital and simplification. And lastly, like all businesses in Australia, we are seeing some wage inflation and the current interest rate environment is impacting customer sentiment and vehicle orders. Now we anticipate that these challenges are short to medium term in nature, and notwithstanding these challenges, we are seeing July and August vehicle orders tracking in line of PCP. And when vehicle supply improves, Smartgroup will certainly be a beneficiary. In the meantime, Smartgroup is well placed, with its capital-light business model and a strong balance sheet. With that, I'll hand back to Rachel for some Q&A.

[Operator Instructions] Your first question comes from Phil Chippindale from Ord Minnett.

First question, just on the Smart Future program, Tim, you mentioned that you're revising the project scope there. Can you quantify how much you're looking to change off that program? And then you also referenced some higher costs there. Will the overall cost of the program remain the same, given that revision in scope, perhaps you could just unpack that a little bit for us?

Yes. I think, Phil, so a couple of things about Smart future, right. We're very deliberate about what we released firstly and then progressively through the Smart Future program. You would have recollected a little while ago, we released some results of some of the things we did to set the foundation, whether it's revising our incentive scheme, whether it's like making our customer -- sorry, our calculator more customer-centric, those are really good results. So it's really important now we now progress to the next phase where we rejig our website, we launch a vehicle sales portal, we changed some of our calculator of salary packaging. Now all those things with the tight environment for tech resourcing comes at a cost. The cost is that, we have elevated cost structures for the people that we've got on board, which are mainly contractors and specialists that could deliver on that. Now those costs those I think, going forward are probably too much, too much for Smart Future program, so now we're trying to pivot that more in-house, recruit more start internally, keep that IP, keep the cost to something more reasonable.

I think it's also important to note that going back over the course of the last 12 months, it has been a tough market to try and get those resources. We have seen some improvement in the ability and availability of that sort of capability. And that's also a good time now for us, to start bringing some of that in-house previously, where it was really hard to source some of these skillsets ourselves.

Okay. Just turning to the point of consumer confidence, which you've referenced as being perhaps a little softer. Just wondering about the timing on that from your observations, when did that start to really turn for you guys?

Yes. I think if you -- I'm pretty sure only bankers will give you a good chart to show the rapid interest rate increases that happened since May. And then certainly, what we saw in our business, was that -- that caught consumers by a little bit of a surprise. So when we're having to requote and get people through another credit application phase, quotes and credit applications that were done pre-May, were redone post May with a big jump in interest rate repayment. So certainly, consumer confidence indented, we're seeing consumers delay vehicle orders, purchasing decisions. That's what we're seeing in July and certainly a little bit of it in June as well. I'm not sure when it's going to turn filled, but I dare say that, it will start to turn when we get a level of stability across -- on interest rate rises.

And certainly, we've been speaking to potential customers, what they've said to us, is that they are taking a bit of a wait-and-see approach. They want to know where their mortgage rates land, so that they understand what their household budget is. And the majority of our customers actually are mortgage holders. So it makes sense for them to work out where interest rates are going till the end.

Okay. Final question for me, then I will let someone else have a go. Just on wage pressure, you mentioned that it's a challenge for costs. However Anthony, I think you mentioned that, that was a revision that occurred around the middle of this year. So is it fair to say that, not that much will be cost line impacted in the first half from that -- those wage revisions, et cetera?

No, on a PCP basis, so we did a mid-2021 wage review. So you'll see the full impact of that in half 1 versus PCP. But certainly, we're not alone in feeling some -- or seeing some wage inflation around. Certainly, we're experiencing what other businesses are.

Your next question is from Paul Buys from Credit Suisse.

First one for me, please. Just a follow-up on what Phil was asking about there, on the Smart Future program. And I appreciate, obviously, I mean, the -- everything you articulated that makes a lot of sense, given cost and resource availability. But just in context of your original kind of guided timeframe, where you're pointing to that sustainable EBITDA uplift, building to $15 million to $20 million EBITDA in 2024. I mean, apart from inferring that, that seems to be pushed up beyond '24, is there any more color you can add in terms of that timeframe?

Certainly, it's not our expectation that -- we're still targeting 15% to 20% in 2024. We're still confident that we will achieve that goal. It's just that some of the deliverables that we were going to roll out as part of the program will be delayed.

And I was just going to add -- sorry Anthony, Paul, I think that we -- during the last release, we showed the market on some of the metrics we're tracking. So those metrics we track quite regularly, we're on top of it. And I've certainly been very, very pleased about what we've seen so far, gives us a lot of confidence that whether the calculator or the website or BSP, I think those deliverables will enhance that target. And no doubt, as a business, we're keeping a very close eye on the deliverable of that firstly. But secondly, once we delivered it, how we manage that, to make sure we get the right outcomes.

And maybe a bit of an academic question, but I mean that's good news that you're still holding to the target, notwithstanding some of those impacts. I mean do I put that down to -- you'd think better than expected on this program, or just put it down to you sensibly, managing expectations from the start?

Well, I'm not sure I'd answer that, but I think, firstly, look, the way we're rolling out the program here has been carefully thought through. So the things that we thought would have the biggest impact first and the easiest thing to do was roll that first. And then secondly, obviously, as we go through the stage gate process, progressively, we will get to some of the other items, which the benefits probably could be a little bit more challenging. But certainly, what we've rolled out to date, we've seen some really good benefits on, what we're going to roll out over the next couple of months, we should see some good benefits from as well.

Okay. And then just on your excess orders, which is $14 million, obviously up from the $12 million that you spoke about previously, but equally kind of flat now on what was -- I think you're already at $14 million in your May update. So kind of 2 questions. Presumably, that's consistent with what you talked about in lower orders, is question 1 to that. And question 2 to that is, is this an impact of lower incoming -- or is it an impact of actually having some order book attrition, whereas in the past it has been obviously a very sticky order book and no doubt still is in total, but are those higher rates, causing some people to drop off now on the requote?

We're certainly not seeing any sort of meaningful change in the order cancellation rate. Yes, we track that quite carefully, and we haven't seen that.

I think, Paul, what it does mean is that, it's just more customer dissatisfaction and a bit more work -- actually a lot more work for us to do, right? What we're having to do for a bulk of the orders in the pipeline, is to go back and requote some of those deals. And also to reassure customers that they can -- that the cars are still there, they are still coming.

And then last one from me. Just you called up EVs, which obviously, from a legislative perspective, still some question marks, but clearly, I mean, it can't hurt, can only help. I guess my question is, -- is there enough supply in your kind of customer sweet spot, if I look at the average car price that your typical customer normally buys and it seems to be -- the average EV is well above that. I guess I'm just trying to understand, to what extent do you see your customer base being able to take advantage of that kind of legislation, even though it knocks a lot of the price on EV, the average EV price is well above your typical customers' car price?

For sure, for sure, Paul. We did a survey a little while ago of probably close to a couple of thousand customers and, one of the topics was EV, right? So what they told us was that, around 50% of customer surveys said that, they will be considering EV for their next car purchase, yes? But just as importantly, they said that the price point for EV really has to be below $50,000 for them to think about it. So at the moment, there's only a couple of models, right, below $50,000 and compared to an ICE vehicle, they are much more expensive. So whilst there is underlying awareness, right, and I think underlying demand for EVs, until we see that price point come down, we're probably not going to see a lot of receptiveness from our customer base. But that said, I know that the EV orders in our book have certainly increased quite a bit. So a bit from a low base.

The next question comes from Scott Murdoch from Morgans.

Just interested in a few more comments around leads versus order take. Obviously, the leads are up a solid amount, but they don't seem to be accelerating from recent updates. So there's one question there. And just in the order take, obviously, flat to down, depending on the period. I know you've commented a bit on this, but just more interested in why they aren't converting? Is it -- are they baulking at the interest rate, for example?

No. I think -- hey Scott. So a couple of things, right. Firstly, I think PCP was a good period, strong period for leads. And so comping against last -- or against PCP, with a 6% uplift in leads, 8% uplift in digital leads is a pretty good result, right. In fact, we've seen leads come -- improve from most channels actually. So that's been really good. Now why aren't they converting? Interest rate is probably partly just one of the factors. As you know, the total cost of ownership for a car, the interest rate component is only a small bit of it, right? You got to add in there, the delays in car supply when you tell someone, they're going to wait 90 days, 120 days, in some cases, more for a vehicle. Customers will have to think about it. They'll say, listen, maybe I don't need it right now. I might take a little while to think about it. But certainly, from our perspective, where we're getting leads in, we're getting quotes in, we're seeing that rate being sustained, which is good. Now it's a matter of getting customers from that quote stage, to an order stage, where we're seeing debottleneck. So Anthony, anything to add?

No, certainly, very pleased with regard to the lead volumes, obviously. Yes, I referred earlier, the customers seem to be saying, listen, that's great, I'll wait and see. As Tim mentioned, they're going through and they're expressing interest and they're getting a quote and then they're getting to that quote stage and saying, 'all right, now that I know the sort of cost I'm looking at, I'm comfortable with that, I need to see what my household budget looks like, once I understand the value or the impact of mortgage rate changes.' So it's really being communicated from those potential customers, as to them waiting.

Okay. And just rounding off leads and conversion. I think in the past, you've provided us some lead conversion metrics, which I can't see that they're here. So safe to assume, it's been probably ticked down a bit with leads up in order to take [indiscernible] mathematically conversion has been down. Is that correct or incorrect?

For sure, for sure. I think the -- look, what we don't want to do, Scott, is provide an update on those charts every time we see you. So we'll provide it annually, I think.