Top Stocks: Consolidated Operations Group (reviewed by: NAOS Asset Management)


Top Stocks is where I ask the best stock pickers in Australia for their three favourite stocks – both international and local, with a spread of sectors, including industrial small caps, technology, biotech, miners and LICs.

We list the stocks, with our guest stockpickers’ descriptions, and then we’ll go back to them get an update – either a change in the list or just the latest on each company.

Below is a recent interview I did with Ben Rundle of NAOS Asset Management about his Top Pick.

– Alan Kohler


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Ben Rundle spoke to Alan Kohler

Just update them and they are Armidale, MNF Group and Smartgroup.

Yep, the only thing I would say is that Armidale has changed its name.  It’s now Consolidated Operations Group.

Right, that will explain why I couldn’t find it on the IRESS.

Yeah, so the code is COG now.  It used to be AIK.

Ben RundleOkay, well why don’t we start with that.  Why did they change their name?

Initially the company was a listed investment company called Armidale Investment Group and at that time it was really just a loan book of equipment leases.  Now over the past say 12 months – actually since about November 2015, the company have embarked on a strategy of acquiring equipment broking and aggregation businesses.  Because of that it’s become more of an operating business rather than a listed investment company.  When it was AIK it had to report a monthly figure for its net tangible assets to the market whereas now it is really an operating group and so the company felt that given the change of strategy, I guess, that it was best to have a new name for the business.

What’s the name again?

Consolidated Operations Group, COG.

What a terrible name!  That’s terrible.

Yeah, it’s an awful name.

Honestly, couldn’t they come up with something better than that?

We gave them that feedback.  So we own almost 20% of the business and we gave them that feedback and they didn’t seem to agree with us, but we think it’s an awful name.

That must have taken them all of two minutes to come up with that!  Oh well…

Not to mention the mouthful trying to say it, but anyway.

Hopefully they’re better at running businesses than coming up with names.

We hope they’re better at running businesses then naming them.

Are you still happy with the business?

Yeah, still happy with the business, since we’ve spoken the share price is down a little bit.  The main reason for that, they made an acquisition back in May actually where they raised a bit over $30 million at 12 cents.  Now, a lot of people and us included basically said well it wasn’t long ago that your stock was 15 or 16 cents.  Wouldn’t it have been better to raise the money at that level rather than 12?  But the difficulty with their strategy in terms of buying broking businesses is that they don’t come up in time with when your share price is at its highest point.  Unfortunately they raised at 12 cents rather than raising a little bit higher.  That’s kind of weighed on the stock a little bit.  Really over the last couple of months it’s sort of gyrated between 12 and 13 cents and it sort of hasn’t.

But in terms of the business we’re very happy with how they’re going.  They made an acquisition as I mentioned, with that cash that they raised which is about their seventh or eighth acquisition in the equipment broking and aggregation space.  The most important thing about the recent acquisition though, is it came with a software they would be able to use across some of their other businesses which will help improve processes and drive synergy.  We hope that not only obviously with this acquisition, add to the earnings, but it will also add to the operating efficiency of the business too.

Give us a picture of how the business looks now?  What is the business?

The business has two parts to it.  You’ve still got the old equipment leasing finance book.  That’s worth about $100 million at the moment and that is loans on business equipment.  Things like machinery or computers and that sort of thing.  Any time a small business needs a piece of equipment they need to finance they can come to COG to be able to do that.

What’s the average size of loan?

Average size of loan is quite small, it’s sort of $1-2 million, and can even be less than that.  The book is about $100 million at the moment.  COG have financed $15 million of that themselves and the rest is finance using a syndication group which is obviously separate from COG.  That’s one side of the business and then the other side is a collection of equipment finance and broking operations.  Now the reason they want to acquire these and I guess for lack of a better word, roll up the space a little bit is because the larger they get in this space, the larger volume-based incentives they receive.  That means they can provide better terms for the customers because obviously they’re buying as a group rather than a small unit and they can hopefully drive business that way by being able to provide better terms for their customers in terms of the interest rates that they pay.

Who’s providing the finance?

The finance is a consortium of some private finance guys, there’s a few banks in there – none of the big four are part of it at the moment.  But that will obviously be a benefit further down the track if they can get some of the big four banks aligned with what they’re doing.

It’s a fixed syndicate.  This syndicate exists, does it, to supply COG?

That’s correct, yep.

What sort of interest rates are they getting and is COG charging?

Well it varies depending on what type of customer it is and what type of loan but interest rates vary anywhere between probably 9 and 15%.  Then COG will make the margin based on where they think they can be applied in terms of the risk to the customer and the risk of the equipment that they’re lending against.  There’s no sort of hard and fast – I’m sure they’ve got internal hard and fast formulas – but in terms of looking at the book themselves, it’s very much on a case by case basis.

I presume the mortgage broking side of the business makes a trailing commission does it?

The equipment, yeah.  They don’t do anything in mortgages, it’s purely in equipment, but that’s right.

Sorry, yeah, not mortgages but…

It works in exactly the same way a mortgage broker does where they get a trailing fee as well.

Yeah, so on one side of the business they’re getting an interest rate margin, on the other side they’re getting a commission.

Correct, that’s right.

Are they at the sort of scale is beneficial now or do they need to keep making acquisitions?

They’re starting to see some of the benefits come through.  It’s our view that they’ll keep making acquisitions as and when they become available.  When they raised $30 million the acquisitions that they made totalled about $23 million, so there’s obviously some residual cash balance there that gives them the fire power to continue to buy other businesses.  I also mentioned earlier that they’re currently financing of that $100 million loan book, $15 million of that is financed themselves.  They could outsource that and use that $15 million to go and buy other businesses as well.

They’re starting to see the benefits but we think that we’re very much at the start of where we think the company can be in a few years’ time.  The CEO, Cameron McCullagh, was the Chief Operating Officer at Steadfast Group.  So Steadfast do a similar sort of thing in the insurance broking space and that business now is obviously very large with a cap of a few billion dollars.  Not necessarily saying that COG will go that large but we do think there’s a long runway for growth.

After the stock price has been depressed as a result of the capital raisings is it cheap?

We think so.  Our valuation if we look out towards FY18 we think they can do 1.1 cents in earnings per share and we valuation that at about 16 times, which gives you a valuation of sort of 16 to 17 cents per share which is about 40% upside to today’s price.  If we look at the following year, if we think they can continue the growth that they’ve exhibited so far, it’s not hard to see in FY19 them doing about 1.6 cents of earnings per share and that can kind of get you to a mid-20 cent valuation which is really sort of only 18 months’ time.  At 12 cents we think they’re very cheap.

Okay, can we move on to Smartgroup now?


What’s been happening with them since we last spoke?  They’re a salary packaging business.

Yeah, that’s right.  They made an acquisition in May, a group called AccessPay which is based in Adelaide.  AccessPay provides salary packaging services mainly for clients in the public benevolent institution sector and they manage about 40,000 salary packages.  To give you an idea, Smartgroup, I think manage about 230,000 packages across their whole group, so adding an extra 40,000 to that.  Importantly, Smartgroup made an acquisition a while ago now called Advantage which also services the same sector in terms of the PBI sector, so we think that there’ll be synergies that are able to take place between this recently acquired group AccessPay and another one they’ve got called Advantage.

We think it’s a smart acquisition.  It continues with the strategy Smartgroup have in place of continuing to buy other smart salary packaging customers which is predominantly how they’ve grown the business over the last four or five years.

Is there much benefit from scale in this business?

Yeah, there is not dissimilar to the example I gave on COG earlier where the scales you get volume benefits in terms of their fixed operating costs.  It’s very much an administration business so the more salary packages they add they don’t necessarily need to add the same amount of cost base to their business.  What we hope you’ll see in that case is a drive in margin expansion and not only that, you’ll also get better terms – part of their business is also in novated leasing as well so hopefully you get better terms on the finance side of things too.

What’s happened with the share price since we last spoke?

Share price I think it’s moved from about $6.50 up to about $7.50.  It’s been a pretty good performer.  The good thing about this business is that they have a decent amount of earnings visibility so a lot of their clients will sign up on at least 12 or 18 months in advance.  They have a very good forward looking visibility in terms of what the earnings are like and also too, there’s not a lot of capex to be spent in the business.  A lot of those earnings drop through to the free cash flow line.  Really a good way to look at the business it’s in quite a boring segment of the market but they do provide a very impressive cashflow.  If you look at the cashflow yield on it it’s about 7 or 8% at the moment.  If you compare that to where interests rates are, a free cashflow to yield of 7 to 8% being reinvested in the business at a return on equity of greater than 20% is quite attractive from our point of view and I think that’s what’s driven the share price higher.  From where we sit it’s still not all that expensive.  There’s no real reason to see why it can’t continue to grind higher over the next 12 to 18 months.

Is this another rollup story?

I don’t want to use the term rollup too aggressively with this one because while they have made a few acquisitions in the past it’s not really a case of they have a targeted amount of acquisitions they need to make.  I think if the business didn’t make any more acquisitions over the next 12 months you’d still see a rise in the share price simply because the cashflow that they’re producing can either be returned to investors or sit on the balance sheet.  I don’t think it’s a case of a business that needs to rely on acquisitions to grow.  They’ll still have an impressive amount of cashflow coming out of it if they keep their business in its current form.  I think that they’ll take advantage of opportunities when they arise but I don’t think it’s a strategy to necessarily have to acquire a certain amount of businesses each year.

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