Acts of Rudd threaten to smite markets mightily
McMillan's client base is predominantly charities and governments because these groups have limited salary budgets, so consequently offer employees deals usually involving making vehicle lease payments out of pre-tax salaries.
Its share price halved last Thursday as questions belatedly emerged about how much of McMillan's profits came from these "novated" lease deals after Australia's Treasurer announced a radical change to the fringe-benefits tax on this arrangement.
In light of this, we would add this to the fund manager's statement: "What God, the church and the state giveth, they can also taketh away." And it got us thinking about other areas that have earnings that are heavily financially engineered.
Possibly the most vulnerable when it comes to the potential for government regulation to inhibit profits are the consumer-lending businesses run by the likes of FlexiGroup (FXL), Money3 (MNY) and ThinkSmart (TSM).
If the government cracks down on disclosure requirements or early termination rules, these companies' earnings should suffer, and their share prices doubly so. After all, these stocks have either doubled in the past 12 months, or are close to doing so.
For example, FlexiGroup's Certegy Ezi-Pay might enable you to buy a ring for $1000 by paying $200 upfront, and then $100 a month for eight months. On the face of it, there aren't any funding costs for the purchaser. In actual fact, the retailer is paying Certegy a margin and the purchaser has no idea of the actual interest rate being paid, because it's embedded in the price.
Another example is that for many such "easy payment" products, if the purchaser gets into financial hardship and isn't able to continue to make payments they are liable to pay the entire amount, regardless of how much has been paid, and whether the good purchased is returned or not.
Stocks with life-insurance income that deliver annuity income streams for investors also have earnings based on financial engineering. Companies like QBE and AMP are at risk if anything goes wrong on this side of their business because of their long-tailed liability policies, whose payouts can stretch for decades.
This was particularly evident in AMP's profit downgrade last month that revealed a lot more executives paying premiums for income-protection insurance had come down with stress-related illnesses than AMP's actuaries had budgeted for.
The earnings of investment management firm Challenger are underpinned by the lifetime annuities it offers its customers. This offer is based on the favourable tax treatment of accepting your superannuation in these terms, rather than in a lump sum.
The biggest area by market capitalisation whose profits are at risk if the government changes its mind is definitely the regulated utility. Government authorities act to limit returns because of their powerful market position.
The companies include Sydney Airport, gambling houses such as Echo Entertainment and Crown, and electricity and gas network owners such as APA and Envestra.
These stocks are often touted as "risk free", but we know from the recent share price action in McMillan, not to mention Echo, Sydney Airport, APA and Envestra, that this is far from the case.
Frequently Asked Questions about this Article…
McMillan Shakespeare’s share price halved after Australia’s Treasurer announced a radical change to the fringe‑benefits tax treatment of novated leases. The market suddenly questioned how much of MMS’s profits relied on those salary‑packaging novated lease deals, after the stock had climbed almost 600% over the prior five years.
Novated leases are salary‑packaging arrangements that let employees make vehicle lease payments from pre‑tax salary, commonly used by charities and government employers. For firms like McMillan Shakespeare, a large exposure to novated leases means changes to tax rules or government policy can quickly hit reported profits and share prices.
The article highlights consumer‑lending businesses such as FlexiGroup (FXL), Money3 (MNY) and ThinkSmart (TSM) as potentially vulnerable. If regulators tighten disclosure rules or early‑termination conditions, these companies’ earnings — and therefore their share prices (some of which have doubled or nearly doubled in 12 months) — could be materially affected.
Products such as Certegy Ezi‑Pay let customers pay an upfront amount and monthly installments, while the retailer pays a margin to the provider. The purchaser often doesn’t see the embedded interest rate, and may remain liable for the full balance if they default, which creates earnings based on embedded funding and exposes the provider to regulatory or hardship‑claim risks.
These businesses rely on long‑dated insurance liabilities and annuity income streams that are sensitive to assumptions, tax treatment and claims experience. AMP’s recent profit downgrade — linked to higher‑than‑expected income‑protection claims — and Challenger’s reliance on favourable tax treatment for lifetime annuities illustrate how claim rates, actuarial assumptions or policy changes can hit earnings.
Regulators and governments can limit allowed returns in sectors where companies hold strong market positions. The article flags Sydney Airport, gambling operators such as Echo Entertainment and Crown, and network owners like APA and Envestra as examples where policy or regulatory moves can reduce profits and send share prices lower, despite being marketed as ‘low‑risk’ stocks.
No — the article cautions that stocks often touted as ‘risk free’ can still suffer sharp price moves if policy changes or regulatory scrutiny hit their engineered earnings. Recent share‑price reactions in McMillan, Echo, Sydney Airport, APA and Envestra show that perceived safety can be undermined by government action or changing market assumptions.
Investors should monitor exposure to government policy and tax changes, reliance on embedded financing or margins, disclosure practices, early‑termination and hardship rules, and long‑tail insurance assumptions. These factors can quickly alter reported profits and valuation for firms like MMS, FXL, MNY, TSM, QBE, AMP, Challenger and regulated utilities.
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