ThinkSmart's northern exposure

The market shake-up that sparked a rotation out of growth stocks into more defensive names has done little to hurt ThinkSmart (TSM), and that puts the stock in a good position to make further gains over the coming year.

Stocks that have enjoyed good upward momentum and that are trading on lofty price earnings ratios are under pressure since American technology stocks listed on the Nasdaq, and high-flying biotech companies, suffered a sharp correction (see Could a new ‘tech wreck’ spread?) and prompted the latest bout of profit-taking among these market darlings.

Indeed, ThinkSmart should be the perfect victim of the recent sell-off given that it has rallied close to 40% over the past year and is trading on a current year price-earnings (P/E) multiple of 22 times – or a 38% premium to the ASX Small Industrials Index.

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But I am not expecting the consumer products financing company to suffer much of a correction because it is poised to become a significant cash generator (and cash is king in almost any environment), and the re-rating of its share price has only really just begun now that ThinkSmart is emerging from a painful restructure.

The restructure involved the sale of its Australian and New Zealand (ANZ) operations to its larger rival FlexiGroup (FXL) for $43 million so ThinkSmart can focus exclusively on the United Kingdom, a market that is around three times the size of Australia.

ThinkSmart offers financing solutions for consumers wishing to make purchases on an instalment plan, such as the zero interest financing being offered by JB Hi-Fi (JBH) or Dick Smith (DSH) – outlets that partnered with ThinkSmart before the FlexiGroup deal.

ThinkSmart has secured partnerships with UK retail giants Dixons and Kingfisher, and is working on winning further deals with other chain stores to offer its financing solutions.

Indeed it’s worth noting Thinksmart’s newly installed CEO Keith Jones was recruited for the post directly from UK-based retailer Dixons.

Using relatively conservative assumptions, I see a further 70% upside to the ThinkSmart share price, which is expected to undertake a capital return to shareholders in the coming months.

Management was initially planning to pay a 7.4 cent a share capital return following the ANZ divestment, but decided to look at all other options to return cash to investors following feedback from key shareholders.

ThinkSmart would not elaborate on what other capital return alternatives it is looking at but told Eureka Report that the original plan to pay 7.4 cents is still on the table. I suspect some might be pushing the company to find a quick way to release the remaining franking credit on ThinkSmart’s balance sheet. The franking credit is worth around 4.9 cents a share.

Regardless of the form the capital return takes, I am still counting on management distributing around $11.8 million to shareholders following the payment of a fully franked special distribution of 3.6 cents a share in February. Management will make a decision on the capital return over the next month or so.

While an early release of franking credits would be a near-term catalyst for the stock, this isn’t a big factor in keeping investors onside amid the market volatility.

The fact is, ThinkSmart is poised to grow its operating cash flow by about 50% in the current year to more than $2 million (its financial year is the same as the calendar year) as it is no longer dragged down by the lossmaking Australian business.

The missteps of the local business are tied more to circumstances than mismanagement. ThinkSmart has historically acted as a broker, with a bank offering the financing to consumers. When the global financial crisis struck, Australian banks hastily withdrew the line of credit, forcing ThinkSmart to recognise a shocking loss in 2012 as it raised its own financing.

ThinkSmart didn’t run into the same trouble in the UK as HBOS had a contractual obligation to keep the credit line flowing. The shedding of ThinkSmart’s ANZ business will return the company to its traditional business model of being a broker and Secure Trust Bank has replaced HBOS as ThinkSmart’s funding partner.

One can also assume a material increase in ThinkSmart’s profit margin and a significant amount of operating leverage given that the cost to serve new customers in the UK is limited to the hiring of an additional business development professional and some information technology staff for back-end system integration.

I am forecasting a relatively conservative 15% uplift in revenue for 2015 and 2016, which should see net profit jump by between 25% and 30% over the respective periods.

There are execution risks but ThinkSmart is well placed to maintain this growth momentum and that’s why investors should not be put off by its seemingly high 2014 P/E. If anything, the P/E shows I am not the only one who is feeling confident in management.

If I were to value the stock based on its potential to generate cash, ThinkSmart’s discounted cash flow (DCF) target price comes in at 68 cents.

Valuation aside, ThinkSmart is also appealing for those looking for onshore exposure to the rebounding UK economy and potential currency movements between the British pound and Australian dollar.

ThinkSmart is an unhedged bet on these fronts, with only around $3 million costs in Australian dollars. You would be hard-pressed to find another ASX listed stock with greater leverage to the UK.

On the flipside, if ThinkSmart enjoys ongoing success in the UK it will prompt shareholders to question the relevance of its Australian listing. This is why I suspect that the $65 million market cap company will not have a chance to grow up to become a large cap Australian stock.

At some stage, it will either delist here or be taken private. Otherwise, it will fall into the crosshairs of a UK-based bidder. Either way, shareholders should expect to be paid some form of control premium on top of fair value. This would be a nice problem to have.

To see ThinkSmart’s earnings forecasts and financial summary, click here.