Consolidated Operations Group are the cogs starting to turn?

Consolidated Operations Group (COG:ASX) is the new incarnation of the old Armidale Investment Corporation (AIK:ASX). COG has been slowly transitioning itself from the old LIC structure to a proper operating business structure over the last two years. COG is now pursuing two main lines of business:

Equipment Leasing targeting SME businesses who are looking to finance goods like fixtures and fittings, IT equipment, commercial vehicles, industrial plant equipment etc. Leasing is a very straightforward business but the immediate benefit of new leases provided to customers doesn’t reflect in profits on day one. Lease accounting means all the costs are booked upfront at the start of the contract but the revenues and profits are recorded over the life of the lease, generally 4 years. Thus, the full effects of any lease written on the bottom line are only felt in future years but this does help to underpin future profits. A similar ASX listed competitor would be Silver Chef limited (SIV:ASX)

Finance Broking & Aggregation this is where COG is targeting a rollup of asset finance brokers and similar platform/membership groups. In this part of the business, COG is looking to take a significant equity interest in these broking businesses or buy them outright. This business model would be very similar to other ASX listed entities pursuing broker rollups strategies like Steadfast (SDF:ASX) or AUB Group (AUB:ASX).

In both of the above business lines the greater volume of business that can be written brings about obviously more profits to COG but notably, profit margins can also be grown over time through better funding costs from banks. This comes about as COG can access better funding and credit terms than smaller operators as they channel more business to the banks.

Thus, this gives COG two levers to pull in order to improve and grow profitability over the next few years as they execute on their strategy and achieve scale.

Betting on the jockey

The man trying to shift the gears at COG and really get this business humming is Cameron McCullough who founded the White Outsourcing business and grew Employers Mutual from $30mil in annual premiums to $1bn in annual premiums. Cameron was also heavily involved with Steadfast (SDF:ASX) the ASX listed insurance broker aggregator for a number of years. Given his previous track record, it is not outlandish to think he can replicate even a modicum of his previous success with COG. If you listen to any bit of marketing spiel by some of the main Australian small or microcap funds managers they all emphasize the critical nature of management in running these smaller, immature businesses. They also flag management having skin in the game to help align interests positively with outside shareholders. Well, Cameron owns circa 20% of the shares and just bought more shares on market at $0.105, which, in itself is an interesting signal to the market.

Dry powder at the ready

COG currently has just under $40mil in capital on its balance sheet ready to deploy on acquisitions that can add to EBITDA and provide additional scale benefits over the next few years. As I have written in the past on other listed rollup strategy plays avoiding buying “lemons” and poor integrations post acquisition are major risks in any rollup strategy. However, a reasonable sample of businesses has been bought and integrated by COG in the last few years and by and large COG management seem to have been successful in managing both these keys risks. Crucially a few acquisitions were passed over following due diligence by management. This gives me confidence that COG is not just doing a deal for the sake of doing a deal. Capital allocation decisions like this are crucial in a rollup strategy even if it comes at the cost of revenue and profit growth in the short term. As the old adage goes “sometimes the best deals you do, are the deals you don’t do” 

Not humming but revving up

COG still has a long way to go to execute on its overall strategy but their last result in Feb suggest that things are starting to come together. The result displayed tangible signs of what this business could grow into over the medium term. The result showed business metrics improving and crucially funding costs are being diversified and lowered as a consequence of the increased revenues and volumes. There is, however, still a lot of scope on both the revenue and funding side moving forward.

Couple the above improving business performance with a share price trading down near its 52-week lows, a share buyback (positive for EPS) which has just been announced, prospects of a maiden dividend in FY19 signalled by the board and the CEO and major shareholder buying stock on market at current prices. To me the above concoction of factors is interesting.