Element Fleet Management Corp T.EFN

RBC

[retiredcf]

November 16, 2023

Element Fleet Management Corp.
#1 high-conviction best idea re-affirmed post-investor meetings

TSX: EFN | CAD 20.75 | Outperform | Price Target CAD 30.00

Sentiment: Neutral
We hosted Element Fleet President & CEO Laura Dottori-Attanasio and CFO Frank Ruperto for investor meetings and we came

away comfortable with EFN as our #1 high-conviction best idea. Here were some of the key takeaways:

• We think EFN's recently announced strategic initiatives should help drive further growth and sustain strong customer retention as: (1) centralizing the U.S. & Canadian leasing functions should help drive greater standardization of lease agreements and centralize pricing decisions with the opening of the Dublin office benefiting from a strong labor pool as there are many leasing companies with offices in Dublin; (2) the opening of the Singapore office should help EFN cultivate direct relationships with Asian OEMs to diversify its originations; hopefully help drive steadier origination activity for its Australia/New Zealand clients; and possibly be a source of new vehicles for EFN's North American clients; and (3) the digitalization/automation initiatives should help further improve EFN's operational efficiency.

• We think return of capital is likely a key catalyst as we enter 2024: EFN plans to redeem its 3 remaining preferred share issues by the end of 2024 and the convertible debenture issue that matures in mid-2024 is in-the-money, so is likely to see holders convert to equity. After that, with EFN generating high levels of FCF with low capex and no M&A appetite, we think investors should see high levels of return of capital, both dividend increases and share buybacks. EFN's dividend payout ratio is 25%-35%, but we think this is likely to increase over time. Over the next 5 years, we forecast EFN to increase its dividend at a 17% CAGR in addition to having remaining FCF used for share buybacks, which starting in 2025 (i.e., after the remaining preferred shares are redeemed), we think EFN could buy back ~4% of shares outstanding per year.

• We think 2024 guidance appears conservative: EFN's positive fundamentals and trends are continuing, which re-affirm our view that EFN's 2024 Basic Operating EPS guidance of $1.41-$1.46 appears conservative given Q3/23 normalized EPS of $0.36 annualized is $1.42, which is already within guidance and we think EFN's positive fundamentals suggest EPS should generally increase Q/Q. Furthermore, if the USDCAD remains favorable, that could add additional tailwinds to 2024 EPS.

  We think Element Fleet is a core holding and our view that it's our #1 high-conviction best idea reflects what we believe is a rare combination of attractive growth and strong defensive attributes, reflecting:

• Attractive growth: we forecast a +15% 5-year EPS CAGR, driven by strong origination growth from normalized OEM production helping alleviate substantial vehicle replacement shortfalls at EFN's clients in the past 2+ years; continued progress winning new customers and cross-selling existing clients additional fleet services; and positive operating leverage. EFN's value proposition is that they believe they can save companies/governments ~15-20% of the costs they spend to manage their own fleet.

• Multiple potential catalysts, including the aforementioned return of capital story (significant dividend increases and share buybacks); normalizing OEM production driving significant growth in originations; and potential significant new client wins.

• Strongdefensiveattributes,drivenbylong-termcontracts(typically3-5years);veryhighcustomerretentionrates(EFNis~99%); and very low credit risk (~3bps historically). We also think EFN can perform well in a recession, high inflation and/or high interest rate environment (and vice versa).

• Attractive valuation, with EFN trading at 14x P/E and 8.5% FCF yield on 2024E, although over the next 5-years we think EFN can grow EPS at a 15% CAGR and that ROEs could expand from ~15% today to mid-20s.

  For additional details, please see our 2 recent reports: (1) "Why EFN is our #1 high-conviction best idea" on November 5, 2023; and (2) "No RickRolling here: Strong Q3/23, 20% dividend increase and 2024 guidance seems conservative" on November 6, 2023.