Under the Radar Monte Carlo valuation for McMillan Shakespeare26.07.2013

As we all know, McMillan Shakespeare's share price halved at one point yesterday as questions belatedly emerged as to how much of its profits came from these “novated” lease deals on employees’ cars, after Australia’s Treasurer announced a radical change to the fringe benefits tax (FBT) on this arrangement.
But what’s it worth?
Its stock got up to $18.64 prior to the trading halt on 16 July. It came out of suspense yesterday and traded as low as $6.75, but has bounced back today and is at $9.50 as I write.
One fund manager we spoke to, who you should know owns McMillan (ASX code MMS) – in fact it is one of his bigger holdings – trumpeted what he terms the “Monte Carlo method” of valuing the stock. Monte Carlo is simply a valuation method used for option derivatives, which utilises probability principles.
In this case, he cited Betfair and TAB’s odds for a Liberal National Party victory later this year of 75 per cent; and the corresponding likelihood for a Labor victory of 25 per cent.
This is important because if the Coalition win, Opposition Leader Tony Abbott said he would scrap the plans to restrict the use of novated leases, meaning it would be business as usual for McMillan.
He comes up with a $13.50 valuation. First he takes a 14 per cent discount on the share price high of $18.64, which gives you $16 if the LNP wins. You give this a 75 per cent probability. Then he takes an Armageddon scenario for the stock if Labor wins, which has it trading at $6.00. This gets a 25 per cent probability. You add them up, and viola, you get $13.50.
As it happens, the broker CCZ Statton Equities has just come out with a discounted cash flow valuation of $13.50 as well, which assumes an LNP victory and business as usual for McMillan. It’s valuation before Labor’s FBT announcement last week was $17.10 and the revised number reflects the increased regulatory risk.

About the Author

Richard Hemming

Investment analyst and Editor of Under the Radar Report

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