ELEMENT FLEET MANAGEMENT CORP.
GICS Reclassification: Valuation Is In The Eye Of The Beholde
Our Conclusion
In our view, the probability of EFN re-rating to a higher multiple, and getting
valued on free cash flow, has increased with the GICS reclassification from
Financials to Industrials. We are not changing our price target of $24, which
is based on 15x P/E (2025E), but we are increasing the valuation for our
upside scenario from $26 (16x) to $31.50 (20x). Upside potential has
increased.
Key Points
We find S&P’s GICS reclassification of Element Financial from Financials to
Industrials extremely fascinating. There has been no fundamental change in
the business, but the stocks to which EFN will be compared will change. For
those that do not care about industry classifications and index benchmarking,
it does not matter. But we know there are a significant subset of investors
that do care about these things. Therefore, the GICS reclassification has the
potential to be impactful.
As financials analysts, we count ourselves among the subset that care about
industry classification. Benchmarking and relative calls are an integral part of
what we do. The primary benchmark for Canadian financials, of course, is
the banks, the biggest index weights. We have covered EFN, in its current
form and the prior iteration for approximately 10 years, and there have
always been conversations about how EFN should be valued vs. the banks.
EFN has re-rated over time, with its current P/E of 14.3x (2024E) at a
premium to the bank average P/E of 8.3x (based on consensus earnings).
However, we can’t help but think there is gravitational pull on EFN’s P/E
multiple given that a portfolio manager allocating incremental money towards
Financials has to think about that decision in the context of the relative
multiple between EFN and banks. That logic, which we believe applies in the
real world, results in a theoretical ceiling on EFN’s valuation multiple.
Does the change in GICS classification from Financials to Industrials change
that theoretical ceiling? We believe it does. The conversation of owning EFN
vs. banks shifts to owning EFN vs. the largest weights in the Industrials
sector (CP, CNR, WCN, TRI and WSP). The benchmark for valuation shifts
massively. Those five Industrial stocks are trading at an average P/E of
nearly 26x (2024E consensus), more than double where the banks normally
trade.
We are not going to argue that EFN will all of a sudden re-rate to 26x, or
even argue that it will trade at 26x with the benefit of time. But what we will
argue is that the conversation for a portfolio manager on whether an
incremental dollar flows to EFN or elsewhere has changed. Valuation is
clearly now in favour of EFN as an Industrial, but how does it stack up to
those benchmark Industrials on other financial metrics? We provide a
summary table in Exhibit 1 on the following page to answer just that.