Is now the time to buy shares in McMillan Shakespeare?

Since the beginning of 2023, McMillan Shakespeare (ASX: MMS) has risen in price by 37%. Adding to that the grossed-up dividend return results in a total return of 42.7% in just under seven months.

At the start of the year, we put together a hypothetical portfolio for the benefit of Stockopedia clients, that we call NAPS. NAPS stands for No Admin Portfolio System. It is constructed using a simple methodology of taking the two stocks with the highest StockRank from each of the ten segments across the equity market, provided they have adequate liquidity.

McMillan Shakespeare was one of the top two in the financial sector with a rank of 98. The rank is determined by calculating scores across the three key factors driving share returns, quality, value and momentum, and then calculating a composite score.

When we went through the same exercise at the start of July, McMillan was still in the top two with a StockRank of 96.

McMillan Shakespeare operate across three segments:

• Group remuneration services
• Asset management services
• Plan and support services

Asset management services is the biggest contributor to revenue at about 58%, but not the biggest contributor to profits as it operates on tight margins. This business is about providing vehicle fleet management as well as an asset finance aggregator. The latter involves providing access to a panel of lenders for finance brokers.

Group remuneration services contributes about 36% of revenue. This business involves salary packaging and novated vehicle leasing.

The vehicle leasing industry has witnessed some unusual effects in recent times. Firstly, new car sales have started to pick up over the last 12 months following a steady downward trend for the past few years. This was exacerbated by reduced production in the early part of the pandemic.

The lack of new vehicle supply has led to used vehicle prices reaching record levels. The drop in new car production at the start of the pandemic has now created a shortage of three-year-old vehicles adding further upward pressure to used car values. Used vehicles prices remain very elevated although they have come down from the peak.

And then there is the electric vehicle (EV) effect. Recent changes to fringe benefits tax for electric and low emission vehicles have made it far more attractive to lease these types of cars. For example, a leased $66,000 Tesla effectively costs about the same to own and operate as a $40,000 Mazda. This has made EVs a far more competitive option. A year ago, they accounted for about 1.7% of McMillian's novated lease orders, but that leapt to 16.1% in the March quarter of 2023.

The third segment is plan and support services. This is relatively small at 8% of revenue, but it is growing strongly with revenue growth of 20% in the first half. This segment provides services to participants in the National Disability Insurance Scheme (NDIS) who require assistance with managing their plan.

There are about 573,000 people receiving NDIS support at the moment and 58% of them require plan management (the others are self-managed). MMS is the second largest provider in this fragmented market with a 5.1% market share.

McMillan is a high-quality business with a Quality Score of 90. Aside from a hit during the COVID panic of 2020, their revenues and profits have been very consistent. The one drag on their quality score is the debt position. Gearing levels are quite high with net gearing at 83%. This includes $206 million in bank debt offset by $113 million in cash.

McMillian has been able to generate strong returns with return on equity now 33%. They have also been increasing their dividend payments at a high rate and underwent a $90 million buy-back in the first half. Dividends are fully franked.

The high returns on equity and capital management have led to a strong appreciation in the price. Over the last 12 months the price has risen by 66%.

Of course, this strong run up in price has placed downward pressure on the Value Score, but it is still very respectable at 73, meaning it is ranked in the top 27% of companies for value. A forecast PE ratio of 15.8 is low for the industry, but about average for the market.

Revenue growth and earnings have been steady but not exceptional. Right now, there are some tailwinds in the areas of EV leasing and the NDIS, but both rely quite heavily on favourable government policies. Regulatory risk is currently working in their favour but that could easily change. For example, the NDIS budget is growing at an unsustainable rate and the program is likely to undergo significant changes in the coming years.

Overall, the stock looks attractive on many fronts, but things to keep a close eye on include debt levels as well as the revenue and earnings growth.

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