ELEMENT FLEET MANAGEMENT CORP.
Very Strong Quarter Overshadowed By Strike Risk
Our Conclusion
EFN produced a very strong Q2 result. Risk of strike action for North
American OEMs does add some near-term uncertainty, but is unlikely to
derail the story. The company is executing to plan with very strong growth in
originations and service income. We would recommend further adding to
positions on weakness. No change to our $24 price target and Outperformer
rating.
Key Points
Potential strike action for OEMs adds H2 uncertainty. Despite a very
strong Q2 result, the company did not update its full-year guidance. This is
largely due to potential strike action at North American OEMs. Management
did state that it would expect to hit guidance even with OEM strikes. We
therefore view the range of potential outcomes for 2023 as being the bottom
end of the EPS guidance range ($1.26) in the event of a major strike(s) and
the top end of the range ($1.31) or above in the absence of a strike.
Just when originations and new orders are hitting stride, the recovery in
OEM production and increased allocation to fleet companies is a material
benefit to EFN. H1 originations are up 33% and are running ahead of pace
relative to full-year guidance for growth of 15%-23%. We are forecasting
2023 originations of $8.7B, above the guidance range, and incorporating a
modest slowing in H2. Q2 new orders of $2.1B show that even without a
work-down in the backlog, originations are trending to the mid-$8B range.
Revenue trending well despite softer syndication numbers. H1 total
revenue is up 14% Y/Y and on pace to be near the upper end of the
guidance range. Revenue growth is being driven by growing assets under
management (+10% Y/Y) and deeper service penetration (servicing income
up 13% Y/Y). Both factors are expected to continue. Syndication was not as
strong as expected. The current interest rate environment is a drag on the
syndication rate and management expects it remain below the normal 2%
range in the near term. We have revised up our 2023 forecasts for net
financing revenue and servicing income, but revised down our forecast for
syndication revenue.
Operating expenses remain high, but still hitting margin targets.
Expenses increased 19% Y/Y and were higher than we had forecast. The
company is investing in people to bolster service levels and to facilitate future
growth. The Q2 operating margin of 55.1% is still within the 54%-55% target
range and we expect full year results will also be between 54%-55%.
The outlook for free cash flow gets less positive. We are not valuing EFN
based on FCF but it is an important part of the narrative. Management raised
expected maintenance capex for 2023 from $50MM-$55MM to $75MM-
$80MM. This is partly attributable to IT spend and partly to real estate
optimization. Management also warned about increasing cash taxes, but did
not provide a tax rate. 2023 FCF/sh guidance of $1.58-$1.63 is unchanged,
but we wonder if there is some risk to 2024E FCF from higher taxes