Smartgroup: Earnings Recovery Likely but Upside All Priced in

We lift our fair value estimate for shares in no-moat Smartgroup SIQ to AUD 7.90 per share, from AUD 7.50, largely reflecting the time value of money. Shares screen as overvalued at current prices. Our forecasts assume revenue and underlying EPS growing at around 5% and 6% per year, respectively, over the five years to 2027. We expect earnings growth will be driven by a rebound in vehicle supply, which supports increased novated leasing and fleet management volumes. Margins should improve as volumes recover, the level of product takeup grows, and more client engagement via digital portals—rather than support staff. Regardless, these positive factors appear to be fully priced into the stock.

We believe the market is assuming continued growth in novated leasing volumes and yields, rapid margin expansion, and/or much lower capital expenditure levels compared with 2022. However, we consider these scenarios unlikely. We believe novated leasing yields are presently at cyclical highs and should decline by 2025, while more rapid margin expansion is unlikely given the labor intensity of Smartgroup’s employee management services. Moreover, we think investors are underestimating Smartgroup’s future capital expenditure needs, most notably increased vehicle purchases for its fleet management business.

We expect Smartgroup’s novated leasing volumes to recover from their 2022 lows, but yields should decline due to increased vehicle supply and resulting lower prices. While Smartgroup is increasing its mix of electric vehicles, we believe the full benefits of this shift are limited. Specifically, we think conventional EVs—commonly priced around AUD 60,000—are likely to be out of reach for most of Smartgroup’s customers, most of whom are: (1) public sector employees at charitable institutions; and (2) tend to package vehicles around AUD 35,000. Instead, they are more likely to opt for more affordable EVs like those from BYD or MG, starting at around AUD 39,000.