Investment Implications
Turnaround complete: ECX has gone through a remarkable turnaround since 2017/18. Six non-leasing business units have been divested, leaving the Group an auto leasing pure play across three brands. Proceeds have allowed almost $300m of debt to be repaid, leaving the balance sheet in a net cash position. Today, the Group is a simplified, efficient fleet manager.
Second-hand car values have boosted earnings: The boost in second-hand car values across the market has delivered three periods of very strong earnings. ECX benefits when vehicles reach the end of a lease and need to be sold.
In the current market, the End of Lease (EOL) has increased from $2.5k per vehicle in 1H20 to almost $9k per vehicle in 1H22. This has seen ECX’s group earnings jump from $172m in FY19 to an expected $258min FY22E.
ECX is likely to have >$130m of excess cash: EOL income through to FY24E is likely to result in ECX with >$130m in surplus cash. This will leave ECX in a strong position to participate in potential industry consolidation, where the benefits of scale are significant.
Just how long strong EOL earnings remain is unknown, with ongoing vehicle supply issues and continuing period of strong customer demand. ECX anticipates a long-run return to pre-covid profitability levels of $2.5k per vehicle. This may not be until 2025/26.
In the absence of any consolidation moves, capital management remains an option. A share-buy back of $100m at current share prices would boost reduce share count by almost 15%, and boost EPS by a similar amount.
Earnings profile and valuation challenges. The market currently assumes that ECX earnings decline from FY22 levels over FY23-25E as EOL income falls, and profitability normalises. The potential growth of the lease book is unlikely to be sufficient to offset lost EOL income. Valuation: the current PER multiple of 7x FY23e is well below the long-term average of 12x. If we normalise EOL earnings, the earnings multiple is closer to 12x.
In our view, the market ascribes little value to any optionality the excess cash affords the company. A 14x multiple on FY23 normalised earnings would equate to a share price of just over $3.00 per share.
Investment View
Since its turnaround, ECX has become a simplified, efficient fleet manager with a lowly geared balance sheet. ECX is benefiting from its elevated EOL income that has been driven by the continued strength of the second-hand vehicle pricing market. Elevated earnings have left the market uncertain the current stock price adequately reflects the group’s normalised earnings.
In our view, we believe the current stock price has largely priced in the group’s normalised earnings. The outperformance in EOL income is temporary, with its end-of-lease income expected to revert to its normalised, pre-covid level of ~$2500 per vehicle by 2025.
ECX is currently trading below its historic PER of 12x on a normalised basis. Despite the market largely pricing in its normalized earnings, we believe that its current share price does not adequately reflect the opportunity that the excess EOL income provides the group – either through capital management initiatives or through investments in consolidating the domestic fleet management industry. Either would likely be highly accretive for earnings.
3 Key Investor issues
Business strategy simplification
Under the guidance of CEO Julian Russell, ECX has simplified its business strategy over the past three years. The divestment of ECX’s non-core assets (Graysonline.com, AreYouSelling.com, Eclipx Commercial, CarLoans, Georgie, Right2Drive) has allowed them to become a pure-play fleet management platform that has three key leading brands – Fleetplus, FleetPartners and FleetChoice.
The divestment of its non-core assets and its tight cost discipline have allowed them to repay its significant debt balance (A$278m at the end of FY18). The transformation leaves ECX as a simplified, efficient fleet manager with a lowly geared balance sheet.
Figure 1: ECX has simplified to three core auto leasing brands
What to do with excess cash?
With second-hand vehicle pricing continuing to deliver robust year-on-year growth and global supply chains showing little if any sign of making a dent in the order backlog that is piling up globally, ECX will continue to experience an elevated EOL income. We estimate that the EOL income could generate >A$130m in excess cash up to FY24.
From this, we can assume A$100m can either be used to engage in capital management initiatives such as dividends or share buybacks, or it can be used to consolidate the domestic fleet market. The current buyback of $40m comes after a $56m buyback in 2021-22.
Over the past 4-5 years, ECX has been an acquisition target, however, a change in its net cash position and a period of above-normal cash flow generation have allowed ECX to go from hunted to the hunter in the M&A space.
ECX currently has the fourth largest market share (10%) in the Australian Fleet market, with SGF having the largest market share of 29.7%. The potential acquisition of a domestic fleet player will allow ECX to increase its market share, like what SG Fleet Group (SGF) did in their acquisition of LeasePlan (2021), which made them a clear market leader.
Valuation Debate
In recent periods ECX has experienced an elevated End of Lease (EOL) income that has been driven by the continued strength of the second-hand vehicle pricing market. After, delivering very solid earnings growth in FY21 (NPATA +169%) and 1H22 (NPATA +58%), the market has been left wondering whether the current stock price adequately reflects the group’s normalised earnings.
The current level of Eclipse’s EOL income at >$8500 per unit is temporary, as once the car market normalizes, the second-hand vehicle pricing market will likely revert to pre-covid levels.
Ultimately EOL income is likely to revert to pre-covid levels of $2200-$2500 per unit. With ECX currently trading at 7x PER, well below its historic average PER multiple of 12x, we believe the current share price has largely priced in the normalisation of earnings.
What the market is not attributing any value to is the optionality that >$130m of surplus cash can bring ECX. A share-buy back of $100m at current share prices would boost reduce share count by almost 15%, and boost EPS by a similar amount.
Risks To Investment View
Risks to our investment thesis on ECX include Quicker than expected reversion on second-hand vehicle prices; Lack of ongoing capital management; Lower than expected demand fleet management and novated leases; Higher than expected cost base growth; irrational pricing from competitors leading to market share losses; and overpaying for potential non-organic growth opportunities.
Figure 2: ECX revenue will likely fall over 2023-25E, as used car prices fall
Figure 3: ECX earnings are expected to halve as used car prices normalise
Figure 4: market share of Auto lease companies
Figure 5: ECX FWD PER is discounting the current period of very strong earnings
