Reverse engineering expectations to yield an edge
A very successful investor I know studies the financial pages of the newspaper with a focus on stocks and sectors that are making 52-week lows. His argument is that if he can find one “diamond” every few years, it more than accounts for the disappointments. And often by a factor!
His assessment was that investors tend to prefer securities that have done well and prefer buying when fundamentals and share price movements have been favourable. While momentum investing has been successful in the long bull market experienced over the decade since the GFC lows, it also generally means selling when the picture and share price is less favourable. And that is when stocks can occasionally become mispriced.
The Australian fleet management sector is out of favour at present and the share price of McMillan Shakespeare (ASX:MMS), Smart Group (ASX:SIQ), SG Fleet (ASX:SGF) and Eclipx (ASX:ECX) are down 29 per cent, 40 per cent, 44 per cent and 78 per cent, respectively, from their 52-week high. And with good reason.
In our article entitled “One plus One rarely equals Three” we discussed the trading update from Eclipx; that their normalised net profit for the five months to February 2019 declined 42.4 per cent on the previous corresponding period; and that McMillan Shakespeare had walked away from the takeover bid for Eclipx.
This is in a backdrop where new car vehicle sales for the March 2019 Quarter are down 8 per cent, year on year, split by passenger vehicles (-18 per cent), SUVs (-4 per cent) and light commercial vehicles (flat). Changes coming from Electric Vehicles, and with high household indebtedness ratios, it seems reasonable the new car is one purchase that can be delayed.
Eclipx previously noted reduced end-of-lease earnings and lower new business writings in fleet as customers extended lease terms. Consumer (car loans plus buying and selling services) had been impacted by lower than expected new car sales and trade-ins arising from market softness.
While it is impossible to know where the bad news ends, it seems likely Eclipx will use their results for the six months to March 2019, which are expected to be released in early May, to “clear the decks”. This is expected to include a write-down of the Grays Industrial and Solvency division as well as the Right2Drive division, and Shareholders Funds at September 2018 year-end could easily decline by $200 million to $700 million by 31 March 2019.
Eclipx core businesses of “Australian Commercial” and “New Zealand Commercial” seem to be largely intact, and if they can replicate the normalised $50 million of profit or earnings of 15.5 cents per share “down the track”, then at the recent low of sub $0.70, the stock could theoretically be trading on a prospective PE of 4.5X.
At 30 September 2018, the Company had debt of $1.8 billion and this was matched by cash of $62 million, restricted cash of $146 million and leases of $1.6 billion. However, with all the moving parts, I still believe a forensic analysis of the balance sheet (at 31 March 2019) is required before bottom-pickers get too excited.