November 5, 2023
Element Fleet Management Corp.
Why EFN is our #1 high-conviction best idea
Our view: We believe EFN’s shares are mispriced (13.5x P/E and 9.5% FCF yield (NTM)), despite growing EPS and FCF/share at +26% and +28%, respectively, in the past year and we think can grow EPS at a +16% CAGR over the next 5 years. We think the recent share price decline presents a very attractive buying opportunity for a stock we believe should be a core holding in any portfolio given we think the stock can do well if markets rally, but also has impressive defensive attributes and should be a relative (potentially) absolute beneficiary in a recession scenario. EFN also benefits from high inflation and shouldn’t be materially impacted by higher interest rates. We think EFN has by far the best risk-reward within our coverage universe, showing a blend of very positive fundamentals; strong defensive attributes; potential catalysts; and attractive valuation. Maintaining Outperform rating, $30 target for our #1 high-conviction best idea.
Key points:
2024 guidance should be announced when Q3/23 results are released tomorrow (Monday). We forecast 2024 Basic Operating EPS of $1.52, above consensus of $1.47 (range of $1.40 to $1.54). Pages 2-3 run through our thoughts on 2024 guidance, but investors should understand we think EFN has been conservative providing guidance as 2022 EPS was +24% above EFN’s guidance; 2023 EPS is tracking well ahead of EFN’s guidance; Q1/20 annualized EPS was already at the high end of EFN’s guidance when the pandemic hit; 2021 had no guidance), so we think investors should not necessarily overreact if 2024 guidance is below consensus, and given our bullish long-term view on EFN, view any share price weakness as a very attractive buying opportunity. Also, F/X could be a tailwind to consensus given recent strength in the US$ (every $0.01 change in F/X for all currencies is ~$0.05 to EPS).
Who wants much higher dividends and share buybacks? By the end of 2024, we expect the remaining preferred shares/convertible debenture to be gone. With EFN generating significant FCF with low capex and no M&A appetite, we think: (1) EFN could increase its dividend payout ratio from 25%-35% to perhaps 35%-50%; and (2) use remaining FCF to buy back stock (we estimate EFN could repurchase ~5% of shares outstanding per year). We think this could be a significant catalyst for the stock.
We estimate an investor could realize a 5-year IRR of +26% purchasing EFN’s shares today, based on our forecast and assuming EFN trades at an 18x P/E multiple (our target multiple) in 2028. Each 1x change in the 2028 P/E multiple = ~125bps to the 5-year IRR.