Slater & Gordon Limited

Transcription

1 BBY Company Research 29 November 2013 Slater & Gordon Limited SGH A$4.39 TARGET PRICE A$5.00 BUY 0.5X Slater & Gordon Limited (SGH) is a national law firm. The Firm's areas of practice include commercial, family, employment, asbestos-related and personal injury law. Moira Daw mxd@bby.com.au Swapan Pandya, CFA sxp@bby.com.au David Fabris daf@bby.com.au This research is current at the date of publishing for any updates to; or the currency of this document, speak to your advisor. BBY does and seeks to do business with companies covered in its research. As a result, Investors should consider this report as only a single factor in making their investment decision. For meanings of ratings and other important disclosures, please refer to the disclosure section at the end of this document. SGH flag flies in UK Slater and Gordon Limited (SGH) entered the UK market in March 2012 and twenty months and five acquisitions later SGH has risen to No 2 (5% market share) in UK personal law services market. The latest acquisition of Pannone (A$55M) brings scale and the cache of a household name. Acquisitions bring integration risk and SGH is well aware of this. It will take a breather for at least 12 months and bed down Pannone and the other smaller acquisitions made during FY14. We think that owning the Pannone brand is a smart move because it puts SGH in control of the brand which it will licence to Pannone Corporate. The EV/EBITDA multiples paid for this acquisition (somewhere in the x range) means that the deal is immediately EPS positive. This acquisition is the step change we have been waiting for. It may be a little early to be 100% confident that SGH has removed the training wheels on offshore acquisitions but all the signs are positive. Acquisitions in our view will remain the key value driver and with a fragmented UK market there should be many more acquisitions to come. We increase our 12 month target price from A$4.00/sh to A$5.00/sh (FY15 PE of 14x, FY15 EV/EBITDA of 9.6x supported by DCF of A$4.92/sh excluding acquisitions). We upgrade our recommendation from UNDERPERFORM to BUY. Key aspects of Pannone acquisition Pricing. We are told that the EV/EBITDA multiple paid was between 3.5x-4.5x which seems to be very reasonable given the size and reputation of Pannone. We estimate that the Pannone business is 52% Personal Injury (PI) and the balance consumer law. This means that the working capital component would have been less than a practice with a higher skew to PI work where the cash conversion cycle is measured in years rather than months. Key staff retained. It was rumoured that there were some difficulties in getting some of the partners across the line so doing the deal with all key staff on board is a major positive Work referral. Pannone Corporate (the remaining~200 staff engaged in corporate and commercial) will licence the Pannone brand name from SGH and will refer personal injury and consumer law work back to SGH. Earnings Changes EPS increase 4%(FY14), 8.9% (FY15) and 11.7% in (FY16). Company Data Number of shares 202M Market capitalisation $888M Free Float (%) month high/low $4.42/$1.91 Average monthly turnover $29M % S&P/ASX 200 n/a % All Ordinaries 0.06 ESG Disclaimer Score (Ranking) n/a GICS Industry Group Consumer Services BBY vs Consensus BBY FY1 Consensus FY1 % Difference EBITDA ($m) NPAT ($m) EPS (c/sh) BBY Technical View as at 29/11/2013 Exit price $4.94 Resistance $4.50 Trend Uptrend Support $4.05 Earnings summary (AUD) Year end June 2013A 2014F 2015F 2016F Revenue ($M ) EBITDA ($M ) Reported NPAT ($M ) Adjusted NPAT ($M ) Reported EPS ( ) Adjusted EPS ( - FD) Adjusted EPS growth (%) Adjusted P/E (x) Dividend ( /sh) Gross yield (%) Net yield (%) Franking (%) ROIC (%) SGH share price performance BBY Limited ABN

2 Financial Summary Slater & Gordon Limited Share Price (A$) $4.39 Mkt Cap (A$M) 888 Year ending June 30 A A F F F Profit & Loss (A$M) 2013A 2014F 2015F 2016F Total Revenue Growth (%) EBITDA Growth (%) Dep'n and amort'n (5.0) (5.0) (5.0) (5.1) EBIT Net interest expense (6.3) (4.8) (8.4) (7.9) PBT Growth (%) Tax (19.5) (25.0) (32.1) (36.2) NPAT Underlying attrib Growth (%) NPAT Reported Normalised NPAT Ord Shares Options Fully Diluted FD Wgted Av Shares Cashflow (A$M) 2013A 2014F 2015F 2016F Customer receipts Supplier Payments (283.3) (294.6) (371.4) (412.4) Net interest paid (5.9) (4.8) (8.4) (7.9) Taxes Paid (0.5) (16.9) (15.7) (20.8) Net operating cash flow Capex (2.3) (5.2) (5.3) (5.3) Net investing cash flow (18.8) (139.2) (25.3) (5.3) Dividends paid (9.6) (13.8) (18.5) (21.3) Net financing cash flow (17.2) (29.3) Net Change in cash 16.1 (47.7) (9.3) 10.3 Net cash at end of period 20.4 (27.7) (37.0) (26.8) Free cash flow Change in working capital (49.6) (40.6) (72.9) (79.7) Balance sheet (A$M) 2013A 2014F 2015F 2016F Cash 20.0 (27.7) (37.0) (26.8) Receivables Inventories Current assets Tangible Assets Investments Goodwill Total assets Payables Current Term debt Long term debt Total liabilities Total Shareholder Equity Investment summary 2013A 2014F 2015F 2016F NPAT reported NPAT Underlying EPS Reported EPS Underlying EPS Growth (%) P/E Underlying (x) Dividend ( /sh) Payout Ratio (%) Gross Yield (%) Net Yield (%) Franking (%) Key Ratios 2013A 2014F 2015F 2016F Profitability (%) EBITDA EBITDA/Rev (%) EBIT EBIT/Rev (%) NPAT NPAT/Rev (%) ROE (%) ROA (%) ROIC (%) Financial Strength Debt to equity (%) Net debt ($M) Net debt to equity (%) Net Debt to EBITDA (%) Interest Cover EBIT (x) Current Ratio (x) Quick Ratio (x) Valuation Operating cash flow CFPS ( - FD) Price/CF BV per share ($) Price/Book Value (x) NTA ($) NTA per share ($) Price/NTA (x) EV/Sales (x) EV/EBITDA (x) EV/EBIT (x) Source: BBY, Company Reports. BBY contributes all company estimates to Bloomberg, Thomson Reuters, FactSet and Capital IQ. Note: Numbers displayed are a sub-set The ESG (Environmental, Social, Governance) score is a measure of the sustainability and ethical impact of an investment in this company or product. ESG scores range from 0.1 (min) to 100 (max). ESG scores are provided to BBY by Bloomberg and are only available for those companies that disclose ESG data to Bloomberg. BBY Limited 29 November

3 SGH - INVESTMENT THESIS Outlook SGH dominates the Personal Injury (PI) market in Australia with 25% market share. It invests some A$12M each year on building and marketing its brand. SGH s brand with its call centre provides a virtual shopfront where enquiries generate a flow of new clients. The SGH brand supports growth in its core PI business and assists it to grow vertically into other branches of consumer law. SGH s management has shown that it is prepared to embrace change. It has been a pioneer in seeking public ownership and breaking away from the partnership structure. It has forged a brand name because it sees itself as a consumer brand and more akin to a retailer of services than a traditional professional services firm. It therefore has a high profile on mass media via television and radio advertising and it also uses social media to continue to build its brand presence. No other legal firm comes close to the brand building that has been SGH s passion for a decade. SGH also uses technology as part of its customer acquisition strategy and to commoditize some of the legal services provided. SGH is using technology to drive down the charge to the customer and to increase its profit margin. SGH believes that consumer legal services will continue to evolve and that the rate of change will continue for decades to come. Management brings commitment and passion to the business. CEO Andrew Grech has been with SGH since 1994 and has been CEO since He has been instrumental in setting and driving its strategic direction. SGH has also been careful to develop its staff and to build flexibility into its management team. SGH has a team of capable practice managers who have already proved to be capable of adapting to change and the challenges brought by acquisitions and geographic and product expansion. In our view SGH is capable of bringing a professional approach to an industry which is largely comprised of small firms and is still something of a cottage industry. We can see parallels with the general practitioner (GP) medical field where GP s operating alone or in small groups find it difficult to compete and to earn comparable returns to the larger GP centres, such as those run by Sonic Limited or Primary Healthcare Limited. GP s like small legal firms still need to fund administration, professional indemnity costs and the like. Returns made by GP s operating in small groups are about half what can be earned by GP s working in larger medical centres. These medical centres have the benefit of cross selling that comes from clustering a wide range of services in the same location. SGH is doing something similar by adding a range of personal consumer law services to its PI practices. In our view SGH will continue to achieve profit margins that are superior to those earned by small practitioners. SGH commenced its entry to the UK market in March 2012 with the acquisition of Russell Jones Walker (480 staff). With the acquisition of Pannone (~400 staff) it has made six acquisitions and has acquired ~A$200M of annual revenue. SGH now has 5% of the personal services and PI law market in UK. The UK market which is 4-5 times as large as the Australian market remains very fragmented with the No 1 player having a market share of 7-8%, SGH at 5%, the next largest players with 1-2% and then a myriad of very small practices. Valuation and target price setting We have based our 12 month target price of A$5.00/sh on an earnings based multiple adjusted for the delay in receiving the cash. We had previously been discounting for a 12 month delay in receiving the cash, however, the business skew in US where after the Pannone acquisition a third of the UK business revenue will be generated from non PI personal legal services where the cash conversion cycle is a few months. Our contention is that SGH now has a track record of solid earnings growth and acquisition success it should trade at least in line with the market, or even at a slight premium to the market. Concerns about earnings matching cash over time in a business dominated by a no win no fee product have largely disappeared. We see SGH as having growth prospects ahead of the market and a team which has shown that it has the depth to manage an aggressive acquisition program. We discount our earnings multiple to reflect the fact that there is a delay of 10 months between recording revenue and receiving the cash. The ASX 200 FY14PE is 15.9x and for FY15 the PE is 14.4x. Our 12 month forecast is set at 14x FY15 PE and a FY15 EV/EBITDA multiple of 9.6x. Our 12 month target price of A$5.00/sh is supported by a DCF valuation of A$4.92/sh. This DCF valuation does not allow for acquisitions that BBY Limited 29 November

4 are yet to be announced. In our view, acquisitions in the UK will continue as SGH uses its market position to seek out attractive acquisition opportunities. Our current recommendation based on our 12 month target price of A$5.00/sh, is BUY. Risks Upside Building on its 5% market share in personal legal services market in the UK and continue to make attractively priced acquisitions. The UK market is very fragmented. The largest player has 7-8% and SGH after the acquisition of Pannone will have 5% market share. The next largest player has only 1-2% of the market therefore acquisition opportunities abound in a market that is 4-5 times larger than the Australian market. PI market in Australia is growing by around between 4-8% per annum. In FY13 enquiries were up 8.5%. Broad based consumer law (or personal legal services) grew by 37% in FY13 as SGH used its brand to build a position in consumer law. The SGH business model is built on its ability to generate recurring earnings. The PI business is non cyclical with no direct impact from changes in the economic climate. It is however, impacted by regulatory change. Acquisition opportunities in other markets (outside Australia and UK) where the legal framework is similar (eg Canada). Margin improvement from increased use of technology. Downside Lag between reporting profit and receiving the cash. The business mix is changing with an increasing amount of non PI work. Funding of working capital. Acquisitions mean the possibility that SGH will pay too much, the business will have unforeseen negative issues or that the integration process is not managed well. The acquisitions in the UK are to be migrated to a new practice management system in September for all practices other than Pannone which will go onto the new system in March Regulatory change is always a possibility although we understand that there are no significant regulatory changes in train. DCF VALUATION Our DCF valuation uses a 2% terminal growth rate and a WACC of 10.3%. Table 1. SGH DCF valuation DCF 2013 A 2014 F 2015 F 2016 F 2017 F 2018 F 2019 F 2020 F 2021 F 2022 F 2023 F 30-Jun Jun Jun Jun Jun Jun Jun Jun Jun Jun Jun Jun EBIT (Total Group Incl. Assoc) TAX DEPRECIATION AMORTISATION MAINTAINANCE CAPEX EXPANSIONARY CAPEX ACQUISITIONS INCREMENTAL WORKING CAPITAL FREE CASHFLOW GROWTH % % 50.1% 37.0% 17.5% 18.3% 8.6% 8.9% 9.2% 13.9% EBITA % 41.4% 46.8% 33.9% 29.3% 25.0% 25.0% 25.0% 25.0% 2014 F 2015 F 2016 F 2017 F 2018 F 2019 F 2020 F 2021 F 2022 F 2023 F FREE CASHFLOW DISCOUNT DISCOUNTED VALUE SUM OF P.V TERMINAL VALUE AT FY2023 F DISCOUNT FACTOR PV OF TERMINAL VALUE PV OF ENTERPRISE DEBT NET VALUE FOR SHAREHOLDER NUMBER OF SHARES ON ISSUE NPV $ 4.92 Source; BBY Estimates BBY Limited 29 November

5 This Research has been prepared and issued by BBY Ltd and remains the property of BBY Ltd. No material contained in this Research may be reproduced or distributed, except as allowed by the Copyright Act, without the prior written approval of BBY. This report has been prepared and issued (in Australia) by BBY Limited (ABN /AFS Licence No ) (BBY) and is subject to the disclosures and restrictions set out below. Analyst Certification: The research analyst(s) identified on the cover of this report individually certify that in respect of each security or issuer that the research analyst covers that: this report accurately reflects his or her personal views about any and all of the subject issuer(s) or securities; and no part of the research analyst s compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or views expressed by the research analyst(s) in this report. 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