Is Slater & Gordon a BUY, Sell or Hold ?

The shares of Slater & Gordon Limited (ASX: SGH) have been beaten down by over 42% in the last four weeks, as the group confronted that the Australian regulators would launch an investigation on the company’s errors in financial reporting. Moreover rumors of the group’s share price manipulation by hedge funds as well as criticism on the company’s extremely aggressive accounting practices have also contributed to the sharp sell off on the stock. Investigation by British regulators on Quindell, wherein Slater & Gordon acquired Quindell’s professional services division for $1.3 billion has also impacted the sentiment.

Meanwhile, the company reported a favorable first half of 2015 performance, posting a revenue increase of 37.6% to $245.3 million, against the corresponding period of earlier year. The firm also improved its normalized EBITDA margin to 23.9%, as compared to 23.1% in 1H15. The normalized net profit after tax rose 46.5% to $35.9 million from $24.5 million in first half of 2014. Consequently, the basic earnings per share improved by 42.3% y-o-y to 17.5 cents. Slater & Gordon declared a dividends of 3.5 cents, against 3 cents during the first half of 2014.


SGH Daily Chart (Source - Thomson Reuters)

With regards to the group’s Australia performance, the revenue rose by 9.2% to $127.7 million, while normalized EBITDA improved by 12.9% as compared to first half of 2014. The personal injury law segment saw an ongoing improvement in Victoria, while remained on track at NSW, ACT, SA and WA. The firm intends to focus on Queensland going forward. On the general law front division in Australia, the family law service is on track while the business and specialized litigation services continue to recover post the adjustment of the year in FY14. Coming to the UK operations, the group has delivered an outstanding performance of year on year increase of 91.5% in revenue to $117.6 million, driven by the Walker Smith Way and Leo Abse & Cohen acquisitions. As a result, the EBITDA surged 101.4% yoy to $28 million. On the personal injury law front the legislative space has been stable while the claims management companies’ consolidation is ongoing. 


First half of 2015 performance by region (Source: Company Reports)
 
 
The group completed its acquisition of Walker Smith Way, a Consumer law focused on personal injury firm in North Wales and North West England in April 2015. Walker Smith Way will transfer four offices to offer strong penetration to SGH at North West England and Wales. The acquisition is estimated to add an annual revenue of over £10.3m. Moreover, the firm also finished the acquisition of Leo Abse & Cohen, a consumer and specialist personal injury company at Cardiff, Wales. Leo Abse & Cohen has a UK wide practice and is specialist in hearing loss claims. Leo Abse & Cohen is expected to generate an annual revenue of £8.4m. The total amount for both of these acquisitions is estimated to be over £18.7 million, with over £10.4m cash on acquisition completion, £3.7 million for equity consideration and over £4.6 million of deferred and conditional consideration over two years after the acquisition completions. 


UK acquisitions impact (Source: Company Reports)
 
 
Outlook

The recent professional services division (PSD) from Quindell is expected generate an EBITDA of £95 million during fiscal year 2016. PSD earnings will comprise core operations as well as the present noise induced hearing loss claims of the company. Meanwhile, the cash from PSD’s core operations would be in line with SGH while the earnings per share accretion from PSD would be more than 30% in FY16. Meanwhile, PSD would not contribute much to SGH during fiscal year 2015. However, the total transaction costs and provisions would be reflected in fiscal year 2015, increasing the tax and accounting due diligence, documentation costs by $9 million.

On the other hand, the Slater and Gordon business is expected to generate a revenue of $520 million during fiscal year driven by organic growth, with Normalized EBITDA margin to be in the range of 23% to 24%. The Cash flow from operations as a % NPAT is estimated to be more than 70%. 


Slater & Gordon outlook (Source: Company Reports)

Given such a strong outlook, we believe that the acquisitions would improve the performance of Slater and Gordon in the coming months, and thus drive the shares higher. Despite the recent allegations, we believe SGH has the capabilities to fight back. Moreover, looks like the markets have overreacted on the news which caused a wipe out more than 53% of SGH share price in the last three months only.  The recent sharp selloff can be used as a buying opportunity by investors and consider adding SGH in their portfolio.
 
Based on the foregoing, we recommend a “BUY” on the stock at the current price levels of  $3.65.

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