Consolidated Operations Group (COG) 10 April 2018 Outperform Upgrade to OUTPERFORM - Inflection point nearing $0.10 Jason Palmer jpalmer@taylorcollison.com.au +618 8217 3965 Summary (AUD) Market Capitalisation $130.8 Share Price $0.10 52 week low $0.092 52 week high $0.158 Ave Monthly Vol (year rolling) 20.687M Key Financials (AUD) Year End ($m) 1H18 Act. FY18 Est. FY19 Est. Revenue 73.9 145.4 176.4 EBIT 7.5 17.6 22.8 NPAT 2.8 6.1 8.1 EPS (c) 0.4 0.8 1.0 Growth (pcp) 67.7% 43.2% 19.7% PE Ratio (x) n/a 12.3 10.3 DPS (c) 0.0 0.4 0.6 Div Yield n/a 3.5% 6.0% Franking 0% 100.0% 100.0% EV n/a 164.4 191.6 EV/EBITDA (x) n/a 7.0 6.8 EV/EBIT (x) n/a 9.4 8.4 ROE n/a 3.2% 4.2% EBIT Margin 10.2% 12.1% 12.9% Payout Ratio. n/a 43.1% 61.7% Share Price Graph (AUD) Earnings Update The 1H18 result continued to highlight positive trends within the Group, namely: (1) 7% growth in NAF on pcp; (2) Additions in platform partner brokers which should underpin earnings momentum into 2H18 and FY19; (3) Increases in some volume base incentives; (4) Firming acquisition pipeline; and (5) Ongoing lease book expansion supported by a sixth funder signing on. Despite this, a slower than expected broker roll-up to date, combined with building corporate disclosures has resulted in considerable share price softness in the past 12-months. Nevertheless, we believe the inflection point for earnings acceleration from acquisitive and organic growth is nearing. To this end, we expect the medium term outlook to be far brighter than recent times. Investment Thesis Operating in an aging and highly fragmented industry with $40m of surplus cash, COG looks unchallenged in the roll-up of the asset finance broker market in Australia. A proven money maker at the helm highly aligned with shareholders is appealing as is the Company s shrewd approach to acquisitions over the past two years. Invoking a buyback for the next 12- months was a surprise given the strength of the acquisition pipeline, however, we expect the take up to be negligible. The growing lease book should lead to significant yearly accounting profit expansion through FY20-FY22. In saying this, cash profit will be significantly backend weighted, and therefore an element of trust me is needed as end of lease returns are evenly recognised throughout the term of the lease. We take comfort that the Group has a long history of average end of lease returns of 22% and that origination growth has been relatively steady since 2012. We also like that a sixth funder has been added to the existing panel at better terms of trade bolstering funding options. Valuation & Recommendation In our view the complexity in valuing a growing lease book while working through the changes in reporting and accounting as a LIC to now a trading company is reflected in the Group's current valuation. We also emphasise management disclosures are on the improvement. This trend is expected to continue into the FY18 Result. We believe a sum-of-parts valuation best suits COG, comprising a DCF on the lease book and a 12x NPATA multiple on the rest of the business (broking, ancillary and head office), a 20% premium to listed mortgage finance brokers. While funding limits allow for ongoing lease book growth in the short-term, these can be removed at any time without notice. History shows this should not be taken as perpetual in nature. To this end, while new business origination of the lease book could exceed $60m p.a. into the foreseeable future, we have allowed for up to a 33% portfolio decline in our calculation of the NPV. In our view this provides adequate downside protection in our valuation methodology. Average monthly traded volumes are ~1.5% of the register. Therefore, we believe a liquidity discount of 15% should be applied to our estimated fair value of 14.2cps. Trading at a 20% discount to our liquidity adjusted fair value of 12.1cps we upgrade our recommendation from HOLD to OUTPERFORM.
Consolidated Operations Group Page 2 of 5 Cons Operations Gp - Summary of Forecasts Price $ 0.100 PROFIT & LOSS SUMMARY (A$m) BALANCE SHEET SUMMARY Year Ended FY17PF 1H18A FY18E FY19E Year Ended FY17A 1H18A FY18E FY19E Operating Revenue 118.6 73.9 145.4 176.4 Cash 39.8 40.6 25.6 15.6 Total Revenue 118.6 73.9 145.4 176.4 Receivables 13.0 11.9 16.0 19.4 EBITDA Adj. 18.2 10.4 23.4 28.1 Lease Receivables 12.2 15.7 16.9 18.1 Dep'n (2.1) (0.6) (1.3) (0.7) Inventories 0.5 0.1 0.6 0.8 Amort'n (0.4) (2.3) (4.5) (4.6) Other 3.7 4.6 4.6 4.6 EBIT Adj 15.8 7.5 17.6 22.8 Total Current Assets 69.2 72.9 63.6 58.4 Net Interest (1.9) (1.3) (3.4) (5.1) Receivables 3.6 3.8 4.4 5.4 Pre- Tax Profit Adj. 14.4 6.4 14.8 18.3 Lease Receivables 34.7 42.4 57.0 71.0 Tax Expense (5.4) (1.7) (4.1) (4.9) Property Plant & Equip 2.3 1.7 1.1 1.1 Minorities (4.1) (1.8) (4.6) (5.3) Intangibles 123.7 142.9 154.4 167.3 NPAT Adj. 4.9 2.8 6.1 8.1 Equity Accounted Associates 4.0 4.1 4.1 4.1 Abnormals (net of tax) (0.6) (0.2) (0.2) 0.0 Other 1.9 1.9 1.9 1.9 Reported Profit 4.3 2.6 5.9 8.1 Total Non- Current Assets 170.3 197.0 223.1 251.0 TOTAL ASSETS 239.5 269.9 286.7 309.4 Margins on Sales Revenue Accounts Payable 17.3 9.3 13.1 15.9 EBITDA Adj. 15.4% 14.1% 16.1% 16.0% Borrowings 16.6 17.7 17.7 17.7 EBIT Adj. 13.3% 10.2% 12.1% 12.9% Provisions 2.5 1.9 3.0 3.7 NPAT Adj. 4.1% 3.8% 4.2% 4.6% Other 2.5 7.2 7.2 7.2 Total Current Liab 38.9 36.1 41.0 44.4 Change on pcp Borrowings 12.4 27.0 41.5 58.7 Total Revenue n/a 35.5% 22.6% 21.3% Provisions 0.3 0.4 0.4 0.4 EBITDA Adj. n/a 38.3% 28.4% 20.2% Other 2.6 10.1 10.1 10.1 EBIT Adj. n/a 16.7% 11.6% 29.9% Total Non- Current Liab 15.3 37.5 52.0 69.2 NPAT Adj. n/a 37.3% 25.4% 32.9% TOTAL LIABILITIES 54.2 73.6 93.0 113.7 TOTAL EQUITY 185.3 196.3 193.8 195.7 S EGMENTS Year Ended FY17PF 1H18A FY18E FY19E CASH FLOW SUMMARY Revenue Year Ended FY17A 1H18A FY18E FY19E Finance Broking & Aggregation 101.0 64.5 125.9 155.1 EBIT (excl Abs/Extr) 6.8 7.5 17.6 22.8 Commercial Equipment Leasing 13.8 6.5 14.1 15.1 Add: Depreciation & Amortisation 1.6 2.9 5.8 5.3 All Other 3.8 2.8 5.4 6.2 Change in Working Capital 1.7 4.1 3.7 (1.0) 118.6 7 3.9 14 5.4 17 6.4 Other non cash/unusual items (0.2) 2.2 (0.2) 0.0 Less: Tax Paid (3.7) (1.7) (4.1) (4.9) EBITDA Net Interest 0.4 (1.3) (3.4) (5.1) Finance Broking & Aggregation 14.7 7.8 18.3 22.5 Gross Cashflows 6.7 13.7 19.5 17.1 Commercial Equipment Leasing 7.3 3.9 7.5 7.7 Net Capex (0.6) (0.1) (0.7) (0.7) All Other (3.8) (1.3) (2.4) (2.1) (Acquisitions) / Divestments (25.2) (1.5) (17.5) (19.8) 18.2 10.4 2 3.4 2 8.1 Net Finance Lease/Advances (20.8) (26.3) (40.9) (15.2) Free Cashflows (39.9) (14.1) (39.6) (18.6) PER SHARE DATA Dividends Paid (1.8) (1.9) (4.6) (7.8) Year Ended FY17PF 1H18A FY18E FY19E Debt issued / (Repaid) 18.6 16.0 30.2 17.2 EPS Adj (c ) 0.6 0.4 0.8 1.0 Equity issued / ( Buyback) 63.0 0.8 0.8 0.0 Growth (pcp) n/a 67.7% 43.2% 19.7% Net Cash Flow 39.8 0.7 (13.2 ) (9.3 ) Ordinary Dividend (c) 0.0 0.0 0.4 0.6 Special Dividend (c) 0.0 0.0 0.0 0.0 VALUATION MULTIPLES Franking n/a 100% 100% 100% Year Ended FY17A 1H18A FY18E FY19E Gross CF per Share (c) 0.7 1.0 1.5 1.3 PER (x) 21.7 n/a 22.1 16.1 NTA per share (c) 7 4 3 2 PER Adj. (x) n/a n/a 16.6 13.2 Dividend Yield (%) 0.0 % n/a 3.5 % 6.0 % KEY RATIOS Free CF Yield - 43.0% n/a - 30.3% - 14.2% Year Ended FY17PF 1H18A FY18E FY19E EV/EBITDA Adj. (x) 6.6 n/a 7.0 6.8 Net Debt / EBITDA Adj. (x) (0.6) n/a 1.4 2.2 EV/EBIT (Adj.) (x) 7.6 n/a 9.4 8.4 Net Debt : Equity (%) - 5.8% 2.1% 17.4% 31.1% EBIT Interest cover (x) n/a n/a 5.2 4.5 Free CF / NPAT Adj. (3 yr avg) n/a n/a n/a -297% Current ratio (x) 1.8 2.0 1.6 1.3 ROE Adj. (%) n/a n/a 3.2% 4.2% Dividend Payout Ratio Adj. (%) 0.0% 0.0% 43.1% 61.7% Assumptions: Nil buyback exercised. Assumes $16m cash deployed towards broker acquisitions in late FY18 and $19.8m during mid FY19. TC has not restated FY17PF for changes in acquisition accounting.
Consolidated Operations Group Page 3 of 5 Peer Comparison and Valuation Thoughts (same methodology The lease book adds complexity to the valuation The fragility of the TL Rental s business became evident during the GFC and the years that followed. Access to capital tightened inhibiting its ability to replenish the book. Off-balance sheet exposures combined with the deferred nature of cash flow earnings adds valuation complexities. We believe the best way to value the lease book is on a DCF basis. A prudent measure in our DCF valuation includes discounting new business origination from current levels of $55m p.a. to $40m p.a. to account for future possible funding constraints. Using this approach we arrive at a fair value on the lease book of $63m as a going concern business or $19.6m if you were valuing the business in run-off. Our DCF assumptions are detailed below. Year of Origination FY14 FY15 FY16 FY17 FY18-20 Lease book origination 15 22 33 42 55 Interest Spread 4% 4% 4% 4% 4% Lease term (4 years) 4 4 4 4 4 Write off rate -2% -2% -2% -2% -2% End of lease earnings 22% 22% 22% 22% 22% Perpetual Growth rate 2.0% 2.0% 2.0% 2.0% 2.0% Discount Rate New Lease Origination into Perpetuity $20m $30m $40m $50m $60m Run-off 10% 31.6 47.3 63.0 78.7 94.4 19.6 12% 27.5 38.5 49.6 60.7 71.8 18.4 14% 24.3 32.5 40.6 48.8 56.9 17.2 16% 21.8 28.0 34.2 40.4 46.6 16.1 COG s business is not of the same quality as SDF or AUB and therefore should trade at a discount to both COG should trade at a discount to SDF and AUB because: 1. Unlike insurance which is largely recession proof, assets finance generation is driven by business trading conditions; and 2. At present independent members only remain part of the Group because VBIs are higher. There is no guarantee this will continue. LISTED AUS INSURANCE BROKERS Mkt Cap PE EV/EBITDA EV/EBIT (AU$m) Yr 1 Yr 2 Yr 1 Yr 2 Yr 1 Yr 2 AUB Group 872 19.9 18.3 14.4 12.5 15.2 13.4 Steadfast Group 1,943 20.7 18.3 12.4 10.7 13.2 11.3
Consolidated Operations Group Page 4 of 5 Instead, we believe Australian listed mortgage finance aggregators are a better valuation yard-stick for COG s broking operations because origination is transaction dependent. In our view COG s broking business is more closely aligned to MOC rather than AFG because it does not take on the financing risk. In saying this, macro conditions remain more appealing for COG into the medium term than it does for the listed mortgage finance brokers, and therefore, we believe COG should trade at a 20% premium or 12x EPS. LISTED AUS MORTGAGE BROKERS Mkt Cap PE EV/EBITDA EV/EBIT (AU$m) Yr 1 Yr 2 Yr 1 Yr 2 Yr 1 Yr 2 Mortgage Choice 217 9.5 9.6 6.2 6.2 6.2 6.3 Australian Finance Group 327 10.5 9.6 29.8 27.0 30.6 27.6 As shown in the table below, we have added back amortisation from acquisition accounting plus taken up the full year benefit of acquisitions in the next 12-months to arrive at a run-rate adjusted NPATA. NPATA Attributable to COG Members Reporting Segment FY19 Finance Broking & Aggregation 7.4 Annualised benefit of FY19 Acquisitions (net of tax) 1.3 Amortisation on acquisitions (net of tax and minorities) 1.8 All Other / Intersegment (1.1) TOTAL 9.3 The sensitivity table below shows the fair valuation impact to the broking business per 1 P/E point. Fair Value on price to earnings basis (Finance Broking & Aggregation + all other) 8x 9x 10x 11x 12x 13x 14x FY18 41.5 46.7 51.9 57.1 62.3 67.5 72.7 FY19 74.8 84.1 93.5 102.8 112.1 121.5 130.8 Our sum-of-parts valuation supports 20% uplift in the share price in the next 12-months Our sum-of-parts valuation arrives at a fair value of 12.1cps based on our FY19e (inclusive of a 15% liquidity discount), a 20% discount to the current share price. Therefore, we upgrade our recommendation from HOLD to OUTPERFORM. Sum-of-parts Valuation FY19 FY19 FY19 FY19 Liquidity Discount 0% 5% 10% 15% Finance Broking + all other 112.1 112.1 112.1 112.1 Lease Book 63.0 63.0 63.0 63.0 Excess Cash (net of Working Capital $5m) 10.6 10.6 10.6 10.6 TOTAL 185.7 185.7 185.7 185.7 Shares on issue 1,307.5 1,307.5 1,307.5 1,307.5 FV per share 0.142 0.135 0.128 0.121 Current share price 0.100 0.100 0.100 0.100 Discount/(Premium) FV 42.0% 34.9% 27.8% 20.7%
Consolidated Operations Group Page 5 of 5 The following Warning, Disclaimer and Disclosure relate to all material presented in this document and should be read before making any investment decision. Disclaimer: Warning (General Advice Only): Past performance is not a reliable indicator of future performance. This report is a private communication to clients and intending clients and is not intended for public circulation or publication or for the use of any third party, without the approval of Taylor Collison Limited ABN 53 008 172 450 ("Taylor Collison"), an Australian Financial Services Licensee and Participant of the ASX Group. TC Corporate Pty Ltd ABN 31 075 963 352 ( TC Corporate ) is a wholly owned subsidiary of Taylor Collison Limited. While the report is based on information from sources that Taylor Collison considers reliable, its accuracy and completeness cannot be guaranteed. This report does not take into account specific investment needs or other considerations, which may be pertinent to individual investors, and for this reason clients should contact Taylor Collison to discuss their individual needs before acting on this report. Those acting upon such information and recommendations without contacting one of our advisors do so entirely at their own risk. This report may contain forward-looking statements". The words "expect", "should", "could", "may", "predict", "plan" and other similar expressions are intended to identify forward-looking statements. Indications of and guidance on, future earnings and financial position and performance are also forward looking statements. Forward-looking statements, opinions and estimates provided in this report are based on assumptions and contingencies which are subject to change without notice, as are statements about market and industry trends, which are based on interpretations of current market conditions. Any opinions, conclusions, forecasts or recommendations are reasonably held at the time of compilation but are subject to change without notice and Taylor Collison assumes no obligation to update this document after it has been issued. Except for any liability which by law cannot be excluded, Taylor Collison, its directors, employees and agents disclaim all liability (whether in negligence or otherwise) for any error, inaccuracy in, or omission from the information contained in this document or any loss or damage suffered by the recipient or any other person directly or indirectly through relying upon the information. Disclosure: This report was prepared solely by Taylor Collison Limited. ASX did not prepare any part of the report and has not contributed in any way to its content. The role of ASX in relation to the preparation of the research reports is limited to funding their preparation, by Taylor Collison Limited, in accordance with the ASX Equity Research Scheme. ASX does not provide financial product advice. The views expressed in this research report may not necessarily reflect the views of ASX. To the maximum extent permitted by law, no representation, warranty or undertaking, express or implied, is made and no responsibility or liability is accepted by ASX as to the adequacy, accuracy, completeness or reasonableness of the research reports. The Analysts remuneration is not linked to the rating outcome in this research document. Taylor Collison may solicit business from any company mentioned in this report. For the securities discussed in this report, Taylor Collison may make a market and may sell or buy on a principal basis. Taylor Collison, or any individuals preparing this report, may at any time have a position in any securities or options of any of the issuers in this report and holdings may change during the life of this document. Taylor Collison has been appointed on-market broker for the share buyback for the period 2 April 2018 to 1 April 2019. Analyst Interests: The Analyst may hold the product referred to in this document, but Taylor Collison Limited considers such holdings not to be sufficiently material to compromise the rating or advice. Analyst holdings may change during the life of this document. Analyst Certification: The Analyst certifies that the views expressed in this document accurately reflect their personal, professional opinion about the financial products to which this document refers. Date Prepared: April 2018 Author: Jason Palmer Release Authorised by: Mark Pittman