What’s the news?
The Australian Financial Review reports this morning that car leasing giant, McMillan Shakespeare [ASX:MMS], is about to be hit with an $80M class action alleging unfair and unconscionable conduct and misleading and deceptive conduct in its extended car warranty business NWC.
Potential profit hit
McMillan Shakespeare has had a good run since late last year, rising 40% from around $10 per share to around $14 today.
But this latest news could have a massive effect on future profits if it succeeds.
And not just for McMillan Shakespeare, but for the whole $85B car dealership industry.
First, a quick confession.
Many years ago I had a finance broking business that dealt primarily in this market.
Now the two ways to profit were on interest rates, and then with after-market insurance products that you could finance into the deal.
Consumers were relatively savvy when it came to interest rates so usually these were used as an enticement to provide the opportunity for the up-sale on the insurance products.
You might only make $250 on the finance, but if you could include a $1495 extended warranty you would make around $700 commission.
There were other exotic products like ‘gap cover’ and ‘consumer protection cover’. They provided very marginal benefits for the price, and that’s why the commissions were so high for the salesmen.
In my opinion 75% of these insurance products were garbage. I tried to stick to the 25% that I felt offered some benefit.
But I knew a lot of salesmen that had no such qualms.
Now, let’s extrapolate that across the industry.
If my experience is a common one and this lawsuit results in an ASIC or consumer led backlash, the hit to McMillan Shakespeare’s profits would be very hard indeed.
And more issues on the horizon
Then there is the potential of a government crackdown on the tax benefits of these car leasing schemes.
This was flagged a couple of elections ago, but was reversed after some intense lobbying.
But we now have another story today saying that the government is looking to crack down on work related expenses, a $20B target for the tax office.
With an industry in the spotlight for the wrong reasons, a government seeking to repair the budget could find the salary packaging industry an easier target this time round.
There is always the chance that McMillan Shakespeare manage to defend the claim, or have it quietly swept under the carpet with a one off hit through a settlement agreement.
However, in my opinion, the risks in the short term are pretty high. And, importantly, they’re out of McMillan Shakespeare’s control.
After a 40% gain in six months, there is always the chance this news will be the trigger for some profit taking to occur as well.
I certainly wouldn’t be considering this as an investment opportunity for now.
Contributing Editor, Money Morning