The shares of Smartgroup Corporation Ltd (ASX: SIQ) have been under pressure from its IPO in July 2014 till the end of 2014, posting a negative returns of over 5.5%, against the loss of the broader index S&P/ASX 200 by 0.5%. However, the stock of Smartgroup Corporation has been delivering an outstanding performance this year on the back of more than forecasted 2014 results, as compared to the earnings IPO prospectus. The group also improved its first half of 2015 guidance as well as entered into new contracts.

Smartgroup reported a revenue of $72.8 million for 2014, driven by increase in packages, 5% better as compared to its IPO prospectus revenue guidance of $69.6 million and 17% higher as compared to $62 million IN 2013. The overall packages reached 118,656 which is slightly higher as compared to the prospectus guidance of 118,457, but 13,489 more as compared to 2013. Novated leases under management improved over 7% on a year over year basis to 32,119, while the staff rose 9% to 343 from 315 last year. EBITA surged 11% to $23.7 million from $21.4 million in 2013. Consequently, the net profit after tax and amortization (NPATA is adjusted to exclude the non-cash tax affected amortization of intangibles) rose to $17.4 million which is 32% higher as compared to $13.2 million in 2013, and 5% better than the prospectus forecasts. However, investors need to note that 2013 NPATA had historical debt structure before the IPO, and NPATA rose 5% in 2014 as compared to the previous year, after adjusting the impact of higher interest expense. Accordingly the group declared a dividend of 6.1 cents per share which leads to a payout ratio of 70% of NPATA for the second half of 2014. 


Smartgroup Salary Packages growth since 2011 (Source: Company Reports)

 
As per the balance sheet highlights, the group’s has built a strong balance sheet in 2014 with the net assets growing to $65.9 million from $29.9 million, partly attributed to the surge in cash and cash equivalents to $27.8 million from $16.9 million in 2013. The firm has been able to improve its cash flow from operations as % of NPATA to 139% from 115% in 2013, by maintain a low recurring capital expenditure at 0.2%.



During February, the group announced an improved forecast of NPATA to $11.5 million (also includes $1.2 million after tax of non-recurring earnings), against its previous estimate of $8.5 million, for the half year ended on June 2015. This is an increase of 35% on a year over year basis. Investors were happy with this update from the company, which led to the stock rally by over 11.4% during the month of February. On June 17^th, Smartgroup reported that it entered into a new contract with the Department of Defense for its salary packaging services effective from July 1^st. The agreement is till June 30^th, 2021. As a result, the shares of Smartgroup rallied 27.6% over last four weeks itself.
Even though the shares of Smartgroup generated a year to date returns of 56.3%, we believe that the stock still has a lot of potential going forward. The company has delivered a solid earnings performance from the past few years, wherein its revenues has surged >50% from 2011, while maintaining EBITDA margins of more than 30%. Moreover, SIQ has successfully improved its operating efficiencies by 23% since 2011. The firm’s employees under management rose by ~30,000 since 2012. Investors should also note that the group has built a solid customer base wherein 75% of its top twenty clients has more than five years relationship with the company. The company’s increase in packages was also driven by solid organic growth, apart from new customer wins.


Relationship term and Revenue by FBT status (Source: Company Reports)

Since 2007, the company was able to win 43% of all public tenders for outsourced salary packaging. The group submitted tenders for nine small to medium sized public salary packaging in 2014, and managed to win three new clients which included Peter MacCallum. The firm has built a strong client base for government and public benevolent institution segments mainly for salary packaging sector. SIQ uses an “asset light” business models and does not witnesses any delays in recognizing revenues, as it receives fees directly from employees’ salaries, reducing its risk of receiving payments for its services.


Package growth since 2000 (Source: Company Reports)
 
Based on the foregoing, we give a “BUY” recommendation on the stock at the current levels of $2.35.

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