|Shares Out. (in M):||386||P/E||9.4||7.6|
|Market Cap (in $M):||5,848||P/FCF||7.1||6.0|
|Net Debt (in $M):||0||EBIT||859||1,023|
Element Financial (ticker: EFN CN) is the market leader in outsourced fleet management. The Company is based in Canada but 70% of assets/revenue/pre-tax are generated in the US. The company recently completed a large acquisition of GE’s fleet management business, which has made Element the largest fleet management company in North America. The deal also furthered Element’s transformation from its legacy as a diverse asset financing company into a “pure play” fleet management business, with fleet management now comprising 70% of the revenue and pretax mix. The deal also changed the revenue mix in fleet to nearly 50% fee based (the remainder being spread income and operating leases). As a scale player, EFN enjoys several advantages vs peers (funding, purchasing, technology). In addition, roughly 80% of the target market for fleet management is still done “in house”. Element estimates its services are 20% cheaper than the “in house” proposition; by taking share in an underpenetrated market and capitalizing on the trend toward outsourcing, Element will likely demonstrate high single digit fee based revenue growth for many years. As evidence of its value proposition/service offering, the Company generates a 4% pretax ROAA (best in class in financials) and a companywide ROTE of 20%+. As Element continues to win deals organically and continues its acquisition of smaller fleet operators, earnings power will continue to expand.
The company currently trades at only 7.5x 2017 EPS (and 5.5x excluding the Company’s $4 tax asset…Element is not expected to pay cash taxes for the next 12 years). This valuation is too low in light of estimated 60% earnings growth in 16 and 20% growth in 2017, double digit organic revenue growth and best in class 4% ROAs. In addition, Element is unique among financials in that it has de minimis credit risk (losses were 0.0% in 2009). We believe that over the next year the Company will trade to $26+ at ~12x fully taxed 2017 EPS of ~$2.00, offering ~70% upside. There are several catalysts which will rerate the stock, including new organic growth wins, execution of synergies in the GE deal, reaching targeted leverage ratios, executing additional M&A, and selling the Company’s Canadian C&V business in 1q2016.
Since its IPO in June 2011, EFN has rapidly expanded its asset financing business and balance sheet through organic growth and acquisitions. The company grew assets from $1.5b in 2013 to nearly $9b in 2014, largely driven by acquiring the US fleet management business from PHH. More recently, the Company again doubled its most valuable division, fleet management, by acquiring GE Capital’s US fleet management business. The deal closed on August 31 and was a transformative acquisition that increased EFN’s balance sheet by 70% and will drive 20%+ EPS accretion. The assets were sold by GE as part of its unwinding of its GE Capital business to become a pure play industrial company. Element’s business mix has now transformed from a diverse asset financing company, composed of 37% commercial and vendor finance (“C&V”), 24% fleet, 20% aviation and 19% rail as of Q2 2014, to 70% fleet, 13% C&V, 9% rail and 8% aviation as of Q3 2015.
Key to the GE deal’s success are substantial expected synergies. Synergies are expected to be $90-95m ($USD), composed of $42-44m in procurement, $18m in interest savings (due to higher credit ratings post deal), and $30-35m of integration savings. EFN has already achieved $60m in savings, with the $30-$35 infrastructure savings still in process. The GE integration is to be fully completed by Q42016. EFN exceeded its costs save estimate in its 2014 PHH fleet management acquisition, achieving $25m of cost savings versus the $20m initially targeted.
Fleet Management Segment - 70% of assets, 70% of earnings
Element’s fleet management business provides a fully outsourced solution that helps corporate clients finance and manage their fleets of company cars and trucks. In addition to providing lease financing for vehicles, Element helps its clients to both minimize the cost of vehicle ownership and to maximize their productivity via data and analytics. Fleet costs are often one the top five “spends” for an organization (think BUD, Sysco, Comcast); the vehicle fleet is a mission critical tool for enabling company employees to perform their jobs.
The Company targets fleets of over 100 vehicles in the US and of over 10 vehicles in Canada, and currently deals with approximately 3,855 different fleet customers and manages 1.3m units. Its customer base represents a diversified mix of industries (33% manufacturing, 11% wholesale trade, 10% communication and utilities, 8% natural resources, 7% construction) and is comprised of generally high-quality commercial customers. The customer base includes around one-third of Fortune 500 companies. Element has a customer retention rate around 98%, and more than 500 customers have been a client for 20 years or more. The managed fleet is comprised primarily of light-duty trucks and cars (61% light duty, 15% cars, 9% medium duty), with small exposure to asset classes such as forklifts (2%) and trailers (2%).
There are 11m vehicles in the addressable fleet and commercial vehicle market. The market has generally been stable over time and fluctuates within a 2-4% variance. The market is segmented by financed and managed vehicles (Element’s niche), owned vehicles (where companies use their own money to purchase vehicles and manage services in-house), reimbursed vehicles (where companies pay their employees an allowance or mileage rate for their personal vehicle), and government vehicles. EFN focuses mostly on the owned vehicle market due to the longer sales cycles in the government channel, although the government channel may be a greater source of opportunity in the future due to growing budgetary and fiscal pressures. The company believes that only around 20% of its target market is currently outsourced.
Element is a dominant player and has 37% share of the US fleet market and 44% of the Canadian fleet market. Privately held ARI is the second largest competitor (23% US share and 31% Canadian share). The third largest competitor in the US is Leaseplan (11% US share). New entrants are rare, with many key players tracing their roots back 60+ years. In fact, the industry has been consolidating since the mid-1990s, with names like CSC, USFL, Leasing Associates, and AMI acquired by current competitors.
Cyclically, there has been a modest rebound in the fleet lease market over the past several years. Frost & Sullivan reported that the fleet lease market has increased just enough to recover units lost in 2008-2009 recession, and projects 3.7% growth in new lease origination revenue CAGR 2012-2020. The market should still be robust as the average age of fleet equipment is still relatively high as customers have deferred capex in the aftermath of the financial crisis. Most of the growth opportunity here, however, is based on an increased outsourcing trend, separate from cyclical factors.
The Company makes money in two primary ways. One is traditional spread based leasing. Leasing (~50% of fleet revenues) is the customer attachment point that leverages the company’s other services. The second are value add services that form the crux of Element’s value proposition. The company’s strategy is to deliver end-to-end solutions that maximize the productivity of clients’ employees and assets at the lowest possible cost. Fee revenue is earned for ancillary services through both recurring monthly charges and transactional activity.
Some specific examples of the Company’s fee based services that help minimize vehicle costs/improve productivity are –
· Vehicle acquisition. Element uses in house engineering and specification experts to minimize customer vehicle acquisition costs and maximize ultimate resale prices.
· Accident management. This includes 24/365 coverage for accident reporting, repair management, and claims recovery.
· Fuel services – Includes point of sale processing, security and authorization controls, and fuel cards to facilitate payments and monitoring. Goal is to minimize fuel costs (which are large and represent ~40% of vehicle expenses).
· Managed maintenance – This includes repair negotiation and screening for duplication, overselling and warranty. EFN charges a fixed monthly fee for access to its supplier network and service discounts. The goal is to minimize driver downtime (a substantial cost of operating a fleet). Element has huge preferential pricing in the maintenance market due to its scale.
· Remarketing - Conservative lease terms coupled with strong remarketing efforts lead to consistent gains-on-sale for clients upon vehicle disposal. Element uses an extensive, multi-channel network including auctions, dealers, retail consignment and online. Personal representation at auctions maximizes returns, consistently exceeding market average.
· Telematics – This is essentially a driver monitoring system. It helps clients reduce risk, costs, and fraud and includes equipment solutions/installation, exception reporting and consulting/trend analysis. The telematics system typically results in reduced fuel use and improved driver and asset productivity, safety, and compliance with fleet policies. Other benefits from closer tracking of vehicle inventory and activity include greater route productivity and service and completion ratios. Element believes this service is only around 30% penetrated, but has the potential to get to 100% penetration.
· Violations /E*Toll Compliance - Suite of services to reduce costs associated with traffic, parking, red light, speeding tickets and electronic tolls.
· Licensing & Regulatory Compliance - Manages and inventories correct titles for every vehicle, including processing for sold vehicles.
· Risk & Safety - Identifies high-risk drivers via Motor Vehicle Record Checks, High Risk program, Driver Profile program. Trains drivers to reduce accidents.