Good afternoon, everyone. Welcome to Element Fleet Management's conference call, webcast, and investor meeting on the topic of accelerated deleveraging. For context, there are a small number of in-person attendees in addition to those joining us on the conference call and online. Callers and online participants are in listen-only mode, and this meeting is being recorded. Element wishes to remind listeners that some of the information in today's call includes forward-looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties, and the company refers you to the cautionary statement and risk factors of its most recent MD&A and AIF for a description of those risks, uncertainties, and assumptions. Although management believes that expectations reflection in these statements are reasonable, it can give no assurance that the expectations of any forward-looking statements will prove to be correct.
Element's earnings release, financial statements, MD&A, supplementary information document, and today's call include reference to non-IFRS measures, which management believes are helpful to present the company and its operations in ways that are useful to investors. A reconciliation of these non-IFRS measures to IFRS measures can be found in the MD&A. After the presentation, there will be an opportunity to ask questions. If you are attending the meeting in person and wish to ask a question, please indicate that to Michael Barrett, Vice President of Investor Relations at Element, who you'll see is present in the room. To join the questions queue as a caller, you may press star then one on your telephone keypad. Should anyone need assistance as a conference call participant, you may signal an operator by pressing star and zero. Q&A will take place at the conclusion of the formal presentation.
I will now turn the call over to Paul Holden of the Canadian Imperial Bank of Commerce.
Thanks, operator. First off, I just want to say thank you to everyone in the room, and thank you to everyone on the line for joining us today. Second, I just want to say a couple quick words of introduction for Jay Forbes and his team. I was just looking up when the announcement came when Jay was first appointed the CEO, and actually, it was roughly right around a year ago. In fact, May 14th, 2018, to be precise, when it was announced that Jay would be appointed CEO of Element Fleet. If you also recall, the share price around that point in time was just a little over CAD 5. I was not having much fun as an analyst, to be honest, covering the stock, and probably most of the shareholders here were probably not all that happy either.
Boy, what a difference a year makes with an excellent CEO. Stock hasn't quite doubled, but close to as of today. My job has become more enjoyable, and based on the faces I've seen this morning, shareholders are a lot happy. More important than that, Jay is here to update you on transformational progress and the plan for the future, and particularly to drill down on the Syndication Initiative, which we learned a little bit about this morning. With that and with a smiling face, I'll turn over the mic to Jay.
Good afternoon. Thanks for joining us for this session, and a warm welcome to those joining on the telephone as well. I'm going to spend a few minutes just giving you an overview of the quarter and some highlights around the Syndication Program, and then open up to questions for myself and Vito Culmone, our CFO, that's in the room with us here this afternoon as well. Thematically, our first quarter can be best summarized with three themes. The transformation of the fleet business is progressing well and ahead of schedule. We're greatly enhancing Element's profitability, and we're strengthening and de-risking the company's balance sheet. For those joining us this afternoon that don't know us particularly well, Element is the market leader in fleet management services in North America.
We provide a full spectrum of services from acquisition and financing through to maintenance, fuel, licensing, and tolls, straight on through to end-of-term remarketing to a whole host of blue-chip clients based throughout the U.S., Canada, Mexico, Australia, and New Zealand. Approximately 90% of our assets are located outside Canada, with the majority of those located in the U.S. Our business model is designed to be resilient, with the ability to deliver strong and consistent results regardless of the economic conditions. Our blue-chip clients, two-thirds of which are investment grade, provide strong counterparty credit. Our widely distributed client base diversifies our exposure to any one specific industry segment. Our fleet management services are indeed essential business services. They are integral to the continuing operations and revenue-generating capabilities of our clients, which ensures that our accounts are kept current.
The nature of both the assets and the relationship that we enjoy with the client create high switching costs and, thus, very low turnover. That, in turn, results in high retention, and given the structure of our contracts, effective protection against defaults and historically strong credit performance. Our scale, both in purchasing power as well as data, allow us to create a compelling value proposition for lowering the client's total cost of ownership. Lastly, our ready access to cost-efficient financing provides strong funding capacity. In October of last year, we unveiled a three-pronged strategy for creating meaningful shareholder value. We wanted to transform the core, strengthen the balance sheet, and wind down 19th Capital. The first of these three, transform the core, is centered on executing a client-centric transformation of our core fleet business to create CAD 150 million in annual pre-tax run rate profitability improvements.
Phase 1 of the plan, our quick wins, saw us identify CAD 58 million of profit improvements in Q4 last year, and we added an additional CAD 12 million of identified profit improvements in Q1. In doing so, we have already identified CAD 70 million of the CAD 100 million we expect to achieve on exiting 2019, setting us up nicely to achieve the full CAD 150 million of run rate profitability by the end of 2020. Importantly, the profit improvements we have identified are already contributing to actual improvements to our bottom line. In Q1, we delivered CAD 11 million of improvement to adjusted operating income as a result of these productivity initiatives. Lastly, we invested CAD 6 million in the transformation program, bringing our cumulative investment to CAD 45 million at the end of Q1. Again, we think the total investment requirement for this 27-month program will approximate our initial CAD 150 million estimate.
On slide nine, having gotten off to a great start with our quick wins, we have morphed into a back-to-basics approach for the transformation program in 2019. Here, our focus for the remainder of the year will be on simplifying, bolstering, or eliminating the policies, processes, or systems that create a superior client experience that we can deliver with consistency. To promote tighter alignment and greater focus throughout the company as we execute the transformation program, we have also introduced a performance management system, the Balanced Scorecard. We have identified four key dimensions: our clients, our business, our people, and our investors. For each of these four dimensions, we have created a strategic pillar. We want to consistently deliver a superior experience and exceptional value for our clients.
We want to, at the same time, improve the productivity of our business, all the while building an engaged and accountable workforce and generating an appropriate risk-adjusted return for our investors. In our future conversations, we will share details of the 15 specific strategic objectives that will drive the collective focus and resources of the company towards the advancement of this strategy. In summary, the strategy is on track with a clear path forward. We have repositioned 19th Capital for a runoff or potential sale, and we have received CAD 26 million in cash in Q1 as a result of the sale of idle assets. We have strengthened the balance sheet. In addition to the Q4 activities, which you would have seen the equity raise, the dividend reduction, as well as the ABS refinancing.
In Q1, we sold excess real estate, sold our interest in ECAF at book value, and completed a successful CAD 172.5 million convertible debenture issue on attractive terms. As we discussed, we are transforming the core fleet business. We have identified with specificity the CAD 150 million in run rate profit improvements and created 17 separate and concurrent work streams that will allow us to permanently reset our pre-tax profitability for these efforts. On slide 12, our efforts on all three fronts were clearly reflected in our financial results for the first quarter. Revenue grew to CAD 238 million, and after-tax adjusted operating income grew to CAD 89 million, or CAD 0.21 a share, some 38% increase year-over-year.
Based on our confidence in the transformation program, the stability and growth we're seeing in the core business, and the syndication strategy that we shared with you today, we've increased the 2020 guidance from CAD 0.90-CAD 0.95 a share to CAD 1.00-CAD 1.05 a share. I'd now like to delve a little deeper into our syndication strategy on slide 15. We are expanding the use of syndication. Having deployed this as a meaningful funding tool in the past, we're looking to expand it go forward to reduce the tangible leverage ratio faster, enabling access to lower cost capital, to mitigate asset concentration created by one large and fast-growing client, and create another source of profitable and recurring revenue for the organization. Syndication accelerates deleveraging and materially improves our return on equity.
Our tangible leverage, which stood at 7.8 times at the end of Q4, has been reduced to 7.4 times at the end of this quarter, and we're targeting a sub 6 times leverage by the end of 2020. Adjusted return on equity, which sat at 9% at the end of 2018, is expected to increase to between 13% and 13.5% in Q4 2020 as we access lower cost of capital and benefit from the new recurring syndication revenue stream. On slide 17, Element views syndication as a complementary long-term funding strategy. In addition to rapidly deleveraging the balance sheet, it can offer superior economics to alternative funding arrangements. With syndication, you get back the principal and net income cash flows when that paper is sold to the buyer. All credit risk and future cash flows belong to the buyer at the time of sale.
In contrast with securitization, principal and net interest income are received over the life of the lease. The combination of securitization through our well-established Chesapeake program and active syndication through the new program we've announced this week gives us greater diversification of funding sources and will lead to, over time, a lower overall cost of capital. In selecting the originations that will be syndicated, we will consider a variety of factors, including client rating, the size of the lease book, as well as the remaining payments. This is probably a good time just to talk about adverse selection. As I stated earlier, we see securitization and syndication as being two complementary funding alternatives for this organization. As such, we will want to ensure that our cost-effective access to the ABS markets remains strong. A large new client is just that.
It is new volume, thus it has not been securitized, its syndication will not impact the existing ABS profile. As for the remaining book of business, we will not and could not, given it would be readily transparent to our ABS investors, dilute the credit quality of the ABS facility. Accordingly, there's no negative implications on syndicating as it relates to the ABS program. While syndication is a well-established funding strategy in the U.S., it's less so in Canada and virtually non-existent in Mexico and Australia and New Zealand. Accordingly, our syndication program will be limited to the U.S. for the foreseeable future. As we think about the key success factors for this program, they really boil down to two essential ingredients, supply and demand. Large, stable demands, coupled with ample supply, ensures that syndication will be a dependable source of recurring revenue sources for this organization.
On the supply side, some of the expanded syndication program is attributable to the need to shift credit risk for that new, large, fast-growing client. Given this client is providing a new source of originations, all of this volume is additive to the supply side. For the remainder, we're simply trading recurring revenue earned over time for recurring revenue earned at a point in time. We have historically originated CAD 6 billion in annual volume, half of which would be eligible for syndication. Therefore, we see no issue in creating ample supply of qualified volume to feed the syndication funding strategy. That's the supply side. On the demand side, syndication market for equipment lease, has ranged anywhere from CAD 12 billion-CAD 23 billion since 2007.
It's highly liquid, very durable, comprised of approximately 80 participants, who are largely comprised of large and mid-sized banks and life insurance companies. We've been active participants in the syndication market for over a decade, know a number of the players and have long-standing relationships with them, accordingly, have a full infrastructure in terms of origination and support for the syndication program that we have administered in the past and will continue to administer going forward. The ready supply of this CAD 3 billion in originations, coupled with strong market demand, give us great confidence that we're going to be able to syndicate with consistency and predictability, which will in turn allow us to successfully execute the syndication strategy, de-leveraging the balance sheet, gaining access to the U.S. bond market, and generating a higher return on equity. With that, I now welcome any questions that you may have.
Thanks, Jay. For the Q&A portion of the event, we're going to try to alternate between questions from the room and from those participating by phone. Thanks in advance for bearing with me as I navigate this bit of to and fro. Operator, can you please remind callers how to ask their questions? Once you've done so, we'll start with a question in the room, which I'll figure out who's going to ask that question while you remind callers.
Certainly. Anyone on the conference call who wishes to join the question queue, you may press star then one on your telephone keypad. You'll hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two.
Thanks, operator. We have a question in the room from MFS.
Hi. I actually have two questions. First, it sounds like every syndication program is going to be started with a clean sheet of paper. If that is the case, and I'm understanding that correctly, how can you ensure that it is a constant and recurring stream without volatility? It kind of leads into my second question, which really, when we think about syndication as originations flow, how should we think about that? In a tougher economy where perhaps purchasers step back because of their own balance sheet issues, and maybe I'm just scarred from the financial crisis.
Yeah. In terms of the syndication program, actually, it is a single undertaking that will have kind of an evergreen status. This will not be a series of newly constructed syndication initiatives, but instead an ongoing process. Just to give you a little bit of flavor, we have looked at our origination schedule as we look at our client profiles, as we look at their fleets and their planned originations for this year. We've mapped that out, have assessed them based on the criteria that I shared with you this afternoon and now have a monthly profile that will watch those originations and prepare to track those originations through to activation, at which time we would then syndicate that. We have a very clear line of sight on a monthly basis as to the portfolio that we will syndicate as the year unfolds.
We're quickly ramping up to develop that type of rhythm, that type of cadence, that type of foresight in terms of the pipeline within the organization on the supply side that will give us continuity of supply to feed the market demand that we anticipate. Coincident to that, we again have long-established relationships with a segment of those 80 participants in that marketplace. We're extending our reach beyond that to enlarge the addressable market for this type of product, have found warm receptivity. Again, given the volumes that we're anticipating introducing into that market, we will continue to expand through marketing efforts and relationship building the relationships to create that awareness, understanding, and translate that into an appetite in terms of a consistent demand for quality product that will help those mainly deposit-taking institutions invest in a reliable short-term asset.
Sorry. Just to clarify, that sounds like the plan for the next 12 to 24 months where you have visibility into-
In 2020 and 2021. If you look back at our originations, we have consistently generated CAD 6 billion worth of originations.
You're operating at the moment with that-
No. Also remember that the syndication strategy is designed to accomplish two main objectives. One is to quickly de-lever the balance sheet to facilitate a second investment-grade rating from a U.S. provider. Which would in turn allow us access to lower-cost capital through the unsecured U.S. bond market. That's one key thrust of this. Think of that as a tranche, a volume that we would be syndicating to facilitate the realization of that objective. Second objective is to manage our credit position vis-a-vis a large and fast-growing client. Okay? When you think of that, think of syndication as the only means. Once you get to a credit whole position on a client, each and every additional dollar has to be syndicated. Okay? Imagine that, if you will, the second tranche volume that you would be drawing from.
That second tranche of volume didn't exist before. That is additive to the CAD 6 billion of volumes that we originate on an annual basis. Process, not project. Evergreen, just keeps rolling. Again, if you think about the nature of it, our fleets have an average life of 41 months. In any given year, you're turning over somewhere between a third and a quarter of the entire fleet. As long as you're maintaining your client base, let alone growing your client base, then that origination number should remain very consistent, highly predictable. Again, the CAD 6 billion of total originations translates into probably, rough CAD 3 billion of volume that could be syndicated. That's just for that single tranche, let alone the second tranche in terms of managing credit.
Stuart, go ahead. Do any of these 80 participants give you pre-orders, or is it every time you bring it to the market, they decide? I have another question, too.
Yeah. Yes, we've had expressions of interest. These institutions have gone to their credit committee, such that they are ready to accept. They know we have the pipeline building, and they've kind of put up their hand and said, "We want it. We're pre-approved, we can transact with speed." We're helping more of those adopt that type of ready, able, and very willing to contract. That said, again, the reputation that we've built, the quality of the underlying paper, when we do show up, again, we receive a very warm reception.
How did the premium that you received during syndication change with the tax cuts? Is there any other tax policy that we should be aware of that could affect the premium in the future?
The accelerated write-down that you referenced certainly was additive in terms of the pricing that we saw in the marketplace. Yes, there was an uptick in terms of the pricing to reflect the accelerated write-off of those types of assets. That tax component, the spread component and the tax component, both of them weigh heavily in terms of the pricing that we receive in the marketplace.
Just wondering, does this fall under the category of Shared National Credit that U.S. banks would participate in? Or is that a separate part of the loan market?
One more time with that. Sorry.
Shared National Credits, which are like syndicated loans in the U.S. that U.S. banks participate in, and there's additional regulatory oversight.
No. That's part of the larger CAD 1 trillion-
Right
market for syndicated assets. What we have been referencing is the subset of that is pure equipment leasing.
Okay. Often banks enter into syndication agreements to get an understanding of the loans, like a toll hold. Do you worry or consider that some of the banks Is this like inviting competition from participants in your syndication?
No. Regional banks are competitors on the finance side in the U.S. for us. They tend to migrate to small, mid-size fleets, and very rarely are they competitive in the mid to enterprise space, which is kind of our bread and butter. We rarely see them compete there. Again, further, the decade plus of relationships that we've enjoyed, we've never encountered a situation where someone was trying to gather intel, trying to improve their own knowledge of pricing in the marketplace to advance their strategy. No, we don't see that as a threat. Again, for us, that end-to-end, the ability to finance, but the ability to provide those full suite of services to a client through that fleet management function is invaluable. We don't find as many clients choosing a financer that is separate from the fleet service provider. Yeah.
What type of clients does this help you go after that you couldn't have serviced on an ABS platform? Are there increasing signs of e-commerce activity sort of fueling that type of revenue generation from new clients or autonomous vehicle, which is quite far out, but you have clients like [Meebon], I believe, in there. Can you give some flavor as to what sort of opportunities set to go after given this is in your arsenal now?
The design of the strategy started truly with this desire to accelerate the deleveraging of the balance sheet, to strengthen the balance sheet, secure that additional investment-grade rating, and to gain access to lower cost of capital, especially in light of the CAD 575 million convertible debenture that matures mid-2020. That was kind of the genesis for exploring this. And the deeper we got into it, the more attractive economically this proposition began. We continue to look at this as an enabler to strengthen the balance sheets, to dealing with the concentration risk of a large name, and for enhancing profitability. We want to be careful to keep the financing decision separate from the business decision.
In terms of the clients that we are pursuing, if you immediately said, "Well, listen, we can just offload any credit to syndication, we really don't need to worry about that." Very quickly, you could start to change the culture, and see a degradation in terms of your NIM and the sales force willingness to kind of get their elbows up and try and negotiate the best possible terms for both parties in the transaction. This won't necessarily drive client mix for us. Instead, we'll look at this as a funding tool, and as we think about how we want to compete in the marketplace, and we think about our embedded cost of capital and returns on that, it will manifest itself in more of the thresholds that we will expect from our sales force as opposed to driving a marketing strategy for the organization.
Jay, how much of the CAD 0.10 lift in the guidance do you think is attributable to the syndication strategy? Then I have a follow-up.
When we looked at the syndication strategy. Our confidence in the recurring nature of that, and that ability to indeed have an ongoing evergreen process of syndication that will run parallel to securitization as a major source of funding. That had Vito and I starting to consider our guidance and, again, based on the renewed confidence that we have in the core business and the stability that we're seeing, the growth prospects that are emerging in the core business based on our continued pace in terms of the transformation and remaining ahead of where we had anticipated being at this juncture. You stir in the syndication and the stability of that revenue flow. That's what gave us kind of those three factors, Tom, gave us the confidence to say, "This is no longer CAD 0.90, CAD 0.95.
This feels a lot more like CAD 1-CAD 1.5 for 2020.
Was Longp oint this large client you speak of in the original CAD 0.90 to CAD 0.95, or did that move it as well?
We had a view to it. We had a view to it. Yeah, again, when we look at those three factors, they all really kind of combine to give us the confidence to increase that guidance by ±10%.
How should we be thinking about the converts next year?
Yeah.
There's a considerable amount of free cash flow still coming here.
Yeah.
I mean, you kind of flipped over half what you had in the other.
Yeah.
Something along that line for next year or?
Very much so. To your point, Tom, we basically with this issue, we went out at half of the CAD 350 that is maturing in June of this year, and we are able to do so through the steps that we took. The repatriation of the Strada Capital and the ABS facility. Some sale of non-core assets. That gave us the ability to, again, halve the requirement to refinance this year's convertible debentures. As we look at 2020 and the June maturity there, CAD 575 coming due. Effectively the CAD 100 million that we have received with regards to ECAF will be applied to that. That will step down to CAD 475. The CAD 25 that we just received, CAD 26 million that we just received from the sale of idle assets in 19th Capital, combined with the proceeds that we would expect to receive between now and June, will again step down that refi.
The CAD 475 then drops to CAD 375 or something less than that. At the very least, we have line of sight to materially reduce the refi requirement as it relates to it. If all the stars lined up and we were able to secure that additional investment-grade rating, giving us access to the U.S. bond market in 2020. That sets up a scenario where there is no need to issue any convertible debentures evermore.
Just to clarify the improvement of funding cost, is it because of that de-leveraging and the lower credit spread on your debt, or is there an ongoing benefit from that syndication? Is that syndication implying funding cost in the syndication more attractive than ABS or other forms as well? I guess.
Again, we had a very honestly, a simplistic point of view in mid-December as we started to kind of tease this out in our own minds and the benefits accruing with syndication just kept on coming and being much more apparent. When we think about syndication and that de-leveraging, we have financial risk for equity holders that is priced into the valuation of this organization. That gets reduced through de-leveraging. The de-leveraging reduces our cost of capital by, again, taking risk away from lenders, replacing convertible debentures with unsecured U.S. bonds, dramatic drop in cost of capital. There is a number of different ways of reducing the total amount of debt outstanding. Absolute amounts of debt outstanding will reduce the interest cost. In so many different ways syndication will have tremendous value for the organization over and above that new revenue stream that we are creating.
Compared to ABS, is it similar?
When we look at the economics of securitization versus syndication over the entirety of the portfolio, the full range of the portfolio, syndication actually has better economics for us than securitization. We thought when we began this that we were going to have to pay a small price to improve the quality of our balance sheet. Again, we were open-minded to it, and we needed to obviously calculate it and justify it in our own minds. As we went to calculate it, there's no cost. This is actually economically value added in terms of the strategy.
Recourse risk?
None. No recourse.
We'll give the operator an opportunity to just remind callers how to join the queue in the event that they'd like to. Anybody in the room has a question afterwards, happy to hear it.
Certainly. Once again, if you have a question from the phone lines, please press star then one to join the question queue.
Thanks. We'll take another one from the room.
I have a non-pure citation question. I wanted to go back to the cost savings plan and the CAD 150 million target. Originally, when you aligned that with investors, you had strived and taken some time with your team, and you were using outside consultants. At the time, you said it was because you wanted a high certainty of delivery, and you needed to develop internal bench strength. Where are you today on the internal team? What are your thoughts?
Yeah. Interestingly, this was the exact question that was asked at the board meeting yesterday. You find yourself in great company in terms of your thinking. Listen, we're absolutely delighted with our association with the Boston Consulting Group. They were part of the strategic assessment process. They worked with management to truly take a realistic appraisal of the business. With that, grounding everyone and with that kind of setting the common knowledge across the team in terms of both the challenges and the opportunities that were available, we built the strategic plan that we shared with you in October. Recognizing where we were, recognizing the pace of change that we wanted to introduce, and recognizing that just some things needed to move much more quickly than the organization had the capabilities to facilitate. We engaged Boston Consulting Group to work with us throughout the two-year transformation.
Couldn't be more pleased with them in terms of partners. Let me give you a specific example of how this works. In our last call, we talked about this client retention program that we had developed. Given the turnover that the business had experienced, it had escalated as a consequence of some integration issues that they had experienced. We needed to get a much better handle at clients at risk, the reason why they were at risk, and a pathway for immediate resolution of those issues so that we would save and maintain those client relationships. BCG brought in some subject matter experts. They worked with our team. They put a fantastic program together, helped them build algorithms, and that is now a fully functioning aspect of our business as being led by an outstanding gentleman promoted from Minneapolis, St. Paul.
BCG has no involvement in that whatsoever. The systems are in place. The process is in place. The policy's in place. Promote is excelling in this leadership of that function. He has full ownership of that. They're done, and they're moving on to another team to help them accomplish the same. That's kind of our pattern. They come in. We balloon in terms of resources that can attack this through a multifaceted perspective. Once the problem has been diagnosed, the solutions have been designed and engineered, and the executive has signed off, then they come out, and their time and effort goes elsewhere. We're effecting a very positive transfer of knowledge and capabilities to our existing leaders who truthfully just haven't had that investment made in them in the past.
Sure. Did you have another one?
Can you give us your outlook on service revenues as the plan progresses, maybe also with this new client, are they taking the same level of service revenues as a normal client would take given their size?
Yeah. I mentioned on our earnings call earlier today that some of our clients have a strong desire for anonymity, some of them have an even stronger desire for anonymity. Let's just say this large, fast-growing client falls into that latter category. I will refrain from offering any commentary in terms of them and their service needs. We had a small dip in Q1 in terms of service revenue. That was largely quarter-over-quarter declines in maintenance as the huge demand for snow tires in October, November, December was on the way into January or February. That was kind of the main driver in terms of the step down in maintenance, which in turn gave us a step down in service revenues.
Otherwise, I'm feeling very good about the unit growth and holding our own on pricing, feeling, again, confident in terms of the profile of service revenues go forward. Again, that in turn gives us the confidence to step up the EPS guidance for 2020.
Who was the large client using before, what's the ramp up time to get them fully ramped up?
I wouldn't be able to offer much in the way of commentary in terms of the past. Again, even on ramp up, I should just sidestep any detail in terms of that. One question that did arise in an early conversation that we had with investors is originations, activations. Can you help us better understand that cycle time? I can, but you may not like the answer because it depends. Originations basically is when we are in receipt of a bona fide order on behalf of the client. There's effectively an obligation on both parties part. We assume that obligation, and we order that vehicle on their behalf, and then obviously follow it through to completion. If that is a GM Silverado that's sitting on Carroll's GM dealership's lot, then we could originate and activate that in days.
If it is for a three-quarter ton dually, that's going to need a complete racking system out back, then that could be seven months. It just really depends on whether it's factory order in stock, whether it's straight or whether it's up fit. There could be a large lag between an origination and activation, or it could be a very condensed timeline. It just depends on what is being ordered and whether or not it's going to be upfitted.
I'll go back to service revenue.
Yeah.
If service revenue accelerated or new sources appeared, would you accelerate your syndication program?
The pace, Stuart, that we indicated, that CAD 600 million a quarter, at this point in time, feels like the right level of volume. CAD 2.4 billion of syndications a year. When we think about, again, the dual objective of managing that credit exposure coupled with delevering the balance sheet, that feels like the right volume for us. If we thought that there was going to be a material change in that view, we would share that update with you.
We've seen a couple of quarters with some very strong origination growth.
Yeah.
Just wondering maybe you can characterize it in terms of putting it across buckets of relevance of new client win at the large club client win, taking market share versus just some strong conditions in your markets on a macro basis that might drive a little higher growth rate for you in general and the industry in general. Can maybe give us that sort of sense and how that feeds into the prospect of overall AUM growth?
We attempted to do so, and again, always looking for your feedback on all the disclosures, but in particular the supplemental. We're trying to provide you as much information as possible of the business, and how we view the business, and the different aspects of the business, without compromising information that would be detrimental in terms of our competition or our dealings with our clients. Some of the information that you have requested would probably fall into that category. The one thing I could reference in the supplemental is indeed the growth that we're seeing in terms of the asset base throughout the three different marketplaces, Canada, U.S., Mexico, and ANZ. That'll give you a bit of a flavor in terms of what's going on in the marketplace. Beyond that, again, I probably wouldn't be able to offer much in the way of commentary.
I guess just in your opening comments you did on the call this morning, you made reference to maybe some competitors that were focused elsewhere, I think was the wording you used.
Yeah, sorry. There specifically was ANZ. There had been a failed merger that took place. Both organizations had been presuming that they were going to receive approval, working towards that end, and were really taking their ball off the marketplace, which gave Aaron Baxter and the team there a good opportunity to continue to advance their interests. In that market, I have said in the past that we tend to do twice, in some years, three times better than market growth. Clearly we're stealing share in that market. It's a well-developed market. The team is very targeted, very disciplined in terms of the areas in which they want to grow and have been very successful in wrestling existing clients of our competitors away from those entities and into our fold. Of course, in Mexico, as you've seen, it's just been fantastic.
These are top-flight organizations. These are the largest companies in Mexico and/or the subsidiaries of international conglomerates that are operating in Mexico. The team have a very compelling offering in terms of service. They have deep relationships of well-respected in the marketplace, and they're going great gangbusters. In Canada and the U.S., again, as we've shared with you, again, when I saw it was an anomaly for the short time that I've been in the organization. No mid-market or an enterprise customer losses in the month of March, and I just happened to ask our COO, Jim Halliday, "Geez, when was the last time that happened?" Four years ago. Okay. Again, does a month make No, of course not. It is a very powerful illustration of the inroads that we're making.
We're getting to the core issues, we're resolving those issues so that that consistent client experience is being maintained. We had 170 some odd clients gather in Minneapolis, St. Paul last month, and we do an annual roundtable and just a great opportunity to interact with the clients. What was fascinating is at any given point in time of the, let's call it 175 clients, the vast majority of those clients are having a phenomenal experience, phenomenal. Best in industry. A few aren't. Next week, you go out to those 175, vast majority of them are having a phenomenal experience, and a few aren't. It may be the same few, it may not. It's that consistency piece. Not that we can't do it. It's actually we are doing it every single day.
It's just the lack of consistency that comes with the inability to rationalize or integrate or address policies, processes, and systems that either don't exist three or four different ways, or just haven't been bolstered in terms of the capabilities. That's what we're going to be focusing on.
Jay, I'm looking at the Balanced Scorecard here. In the investors section, you have two items. One, earn a fair rate of return on capital. It says 13 and a half. Would you classify that as a steady state fair rate of return on capital? That, and second, if you can sort of just flush it out, currently managed risks or enterprise risk index.
Yeah.
What does that mean?
Yeah.
Those two things.
Yeah. Specifically, we're actually looking to earn not only a fair rate of return on capital, but an appropriate risk-adjusted return on capital. Again, that's another reason why we believe stepping down the leverage in the organization, and taking some of that financial risk away as an overhang in terms of the valuation of this organization is important. One of the four metrics that we have set forth is the enterprise risk index. We showed our Balanced Scorecard to the organization today, and across that is a big work in progress. Okay? What is it? Don't know. Haven't even started. Won't start until the second half. What we know is that we need to increase the awareness and active involvement of the employee group in identifying and managing risk in the organization. It hasn't been a strong theme.
It hasn't been part of our culture in the past. Vito has taken responsibility as executive sponsor. We have launched an Enterprise Risk Management program. We're working with the board, bringing them up to speed as we refine that. Then we'll begin to cascade that throughout the organization. As we do, we'll probably identify five or six different risks that will comprise the risk index and give us an idea as to how we're progressing in terms of the management of those exposures for the organization. Whether cybersecurity ends up in there, again, we're not prejudging the outcome. Instead, what we have been adamant is as we think about the cultural complexion of this organization going forward, we need to have a greater awareness of and exercise greater control over the risk profile of all aspects of the business.
Maybe I'll add, Jay.
Yeah.
When you think about our financial risk or when you think about our credit risk, those are very well-developed, finely honed sort of practices. Always opportunity to improve them. Those are core to our business and obviously have, as you see through the results, are effectively managed. We will incorporate those in our ERM strategy, of course, but don't want to leave anybody with the impression that those items are not calibrated and not well-developed because we're very much so in those areas.
Jay, you talked about the CAD 600 million, I guess, syndication a quarter. It works down sort of the bucket on what goes to de-leveraging in that. Say you get to the end of Q4 2020, and you kind of hit your 6 times tangible leverage. You're humming along CAD 600 million a quarter in syndications. Would you like to maintain that tangible leverage at 6 times, and then would you rather toggle that with maybe reduce your syndications a little bit? Do you see it as more like then you start to get into different capital return scenarios where buybacks would be your toggle as opposed to reducing that CAD 600 million in syndication a quarter?
Yeah. To your point, Rob, that's where it gets very interesting. Once you kind of get to quote unquote, that optimal level of leverage where you've finally managed that trade-off in terms of financial risk and cost of capital. Given the cash flow generation profile of the business, which again, part of the supplemental disclosure, we're trying to give you a better feel for that. It creates a tremendous amount of optionality for this business and puts at the forefront of the board of management capital allocation decisions as it relates to shareholders. Again, it's out there. We're comfortable that we're progressing in the right direction at the right speed, and as we mature, the results in line with that will bring some additional thoughts in terms of where we think the business, what options it might have and how those options might be pursued.
No questions on the phone line, sounds like and looks like.
Is there any sort of point in time that you envision where the way you present the economics of the business will change? Obviously, it seems like you're focusing on taking down leverage, being less of a balance sheet business. Internally, when your sales people are working with clients, how do they think about pricing the business and maybe the economics of the business? Is it some sort of CAD margin per unit serviced? Just curious on internally, this is helpful, but more of just how does that work internally with people?
Yeah.
Nothing specific. I'm just more curious.
Yeah. No. Milan, actually, I had the same question. Delightfully, our Treasurer, Karen Martin, agreed to lead a pricing review for the entirety of the organization. We're midway through that. She had to kind of put a little bit of it on the back burner as we advanced the syndication through Q1. We want to get a better understanding of how our value proposition manifests itself in a pricing strategy and whether we're earning a fair rate of return on the capital that we're deploying, whether as we think about the pricing, are we discounting services in order to get finance and business? Maybe the financing business is skimpy in terms of the basis points. If we've asked the question, it kind of gives you an idea as to we think there's opportunities.
As I indicated at the tail end of this morning's earnings call, one of the very interesting attributes of being involved in these types of turnarounds is you start out with a thesis. That thesis gains life. It starts to get substantial in terms of proving itself out and generating returns. The fascinating byproduct is it just starts to clear away things. You go, "Wow, I didn't really think about that before," or, "I wouldn't have guessed that." Syndication is a perfect example of that. At no point in time did that come on the radar screen for consideration through four months of crawling through every crack and crevice of the organization. We just weren't able to, given all the other priorities and everything else that just needed to be done, perhaps on a more timely basis, we didn't have the opportunity to delve into this.
Now that we've got the balance sheet restructured and given ourselves some breathing room, gosh, guess what? You can actually stand back and see these types of opportunities. That for me is kind of the exciting piece. It does not take away, it does not in the least distract from the pursuit and the attainment of the CAD 150 million. It does go to, for all intents and purposes, we could easily go, okay, well, the 150 is now substantially more of that if we put syndication in. Well, we're going to keep the 150 pure and just start to stack up a few other alternatives alongside it. Yeah, pricing absolutely is an area of great interest, and we think there's probably some opportunities there.
Yeah. I guess we're solving the same thing of the idea of from your target returns to your current returns, the incremental returns would be much higher. How does this look like, I guess, going forward would be of interest.
Yeah.
Sorry, sir. We do have somebody on the phone, there will be time for you to ask as well. Go ahead, operator.
Thank you. Yes, we have a question from Mario Mendonca with TD Securities. Please go ahead.
Good afternoon. Jay, could you just address one thing? The syndication clearly takes down the balance sheet risk. I get that part. Do you feel that in some way you've swapped that balance sheet concentration for what I'll call, let's call it syndication concentration or even service fee concentration? If ultimately this very large account is contributing meaningfully to the originations and therefore to the syndication revenue, how do you address the notion that syndication then just becomes highly concentrated to this one particular account?
Yes. Mario, again, I think it's best to look at syndication through the lens of objectives. One is decrease or avoid any single name concentration risk. The second is the de-leveraging of the balance sheet. You can actually bifurcate the syndication volumes in that manner. There will be a stream of originations that go to activations, that go immediately to syndication that is represented by the large, fast-growing client. There's a second stream that is totally independent of that client. Let's say that new client just stopped doing business with you tomorrow, then you don't do that syndication. Guess what? It doesn't impact our de-leveraging of the balance sheet whatsoever because we've never had the volume before. It's new volume now. If it's volume that disappears tomorrow, again, would obviously be a loss in attendant revenue.
It would not negatively impact the de-leveraging scenario that we're undertaking. These run parallel. They'll be combined under the one syndication program, they will run kind of parallels to streams that contribute to that CAD 2.4 billion of syndication volume, and the revenue that's being generated from same.
You're not suggesting that if that large account stopped originating with EFN that it would have no effect on the company's earnings and the guidance you provided. That's not what you're suggesting to me?
That's not what I'm suggesting.
I think maybe the takeaway for me is, at some point over time, if this company continues to grow, and we suspect it will, and it becomes a larger and larger part of your business, I think investors are going to need to understand just how important this client is, whether it's on the balance sheet or not.
We would be aligned.
Yeah.
The other piece, again, as we just think through the syndication piece is it is the situation wherein in order to do business with any name. We syndicate our largest client, we syndicate our second largest client, we syndicate our third largest client. Again, there's a certain exposure that we can take and be comfortable in terms of the inherent risk that we want to have from a credit profile. That excess ends up getting syndicated out. This is a very common means for us to retain the relationship with a client, retain the opportunity to service those clients, and transact on their behalf. Because as you appreciate, transacting on their behalf is quite additive to the billions of CAD of purchasing power and billions of bits of data that we accumulate.
Looking after those clients has a significant value for us, and syndication has been, is, and will be a means for us to provide continuity of all large-scale relationships.
Yeah. My only point is that concentration risk isn't limited to a balance sheet. I guess that's where I'm going with all this.
It is. Yeah. Again, the concentration risk disappears upon the balance sheet in terms of syndication.
I get it. We'll have to agree to disagree. Thank you.
Okay.
Just one to service revenue. Historically, there were some big plans for service revenue. There was Cassandra, I think. Just when you think about it over the next, say, three to five years, and you think about the future of service revenue, are there things that will eventually require capital, or are there things you're thinking of out of the box that you buy from someone else? How should we think about that time horizon?
Yeah. We welcomed Vineet Gupta as our new CTO in mid-January. Vineet has immersed himself into the business very quickly, and has already got his arms around the IT agenda and how it's going to enable the remainder of our transformation agenda. Thematically, again, two early themes that have emerged. One is the cloud, and the second is control and active risk management. As you know, he has done his inventory. He's assessed where we are, where we want to be. This notion that we need to own infrastructure, that we need to own applications is dying away very quickly. We would need to own proprietary applications. All else should be rented and used on a distributed basis.
As we think about the transformation of the business and the back to basics this year and the build for the future in 2020, we envision a goodly amount of that remaining CAD 150 million of investment going to investments in information technology. Again, we want to strengthen the platform such that we exit 2020 with by far the strongest capabilities in the industry. Again, as I've shared with a number of you in previous conversations, I have met our competition. We have hired away from our competition. We have stolen clients from our competition. I'm very comfortable as to how we're positioned in the industry in terms of what we have today, which bodes very well given what we plan to have over the course of the next 20 months of executing this transformation agenda. Fine points, too. Yeah, that ability to mine data.
No one in North America has anywhere near the fleet volumes that we do. No one has greater line of sights in terms of the operational costs of those fleets than we do. That ability to take this competitive advantage in terms of the data set and the knowledge that it would enable, and to properly mine it and provide those insights such that those fleet managers can meaningfully lower their total cost of ownership and demonstrate that productivity within their organization is the secret sauce. The work that Tom Peterson and his Strategic Consulting group do in our organization, and the capabilities that have come up here in the last three to six months are nothing short of phenomenal.
Again, being able to mine those insights and provide that information in real time in an informative manner that the client can act on, that's kind of the first evolution of the value add proposition that we're looking to achieve kind of short to midterm. In my own mind, I go midterm and beyond, is how do we enable the client's fleets to be an enabler to the realization of the overarching strategic objectives of that organization? You are part of that organization, your department, you're probably labeled a cost center. How do we help you advance the overarching strategic objectives of the organization by virtue of the deep insights that have been afforded to you, and that ability to influence the operations of the business. Think telecoms, and think about work vehicles, and dynamic positioning of those work vehicles.
That's what we're capable of enabling, I believe, midterm and beyond. Hey, Eric.
Just on the direct cost. The increasing size of the underlying managed asset base, does it change your view long-term in terms of, I guess, the levers you have there from a negotiation perspective? Especially when you have a larger client, does that give you a sense of negotiation power of direct costs, I guess, in general?
I'm sorry, I'm not sure if I follow you.
The direct costs are closed for the system at this point.
Yeah.
How you're going to grow over time is the underlying managed asset base grows. Now the speed or pace at which that grows can be faster. Does that give you a different negotiation power?
It does. Yeah. It does. Again, interestingly, we'd be one of the largest procurers of tires in North America. Okay? So, your ability to secure rebates on behalf of yourself and your client grow with that type of purchasing power. We have the ability, by virtue of our accelerated application, to direct clients' drivers to Pep Boys or Jiffy Lube in terms of an oil change. That ability to dynamically choose which one to direct them to based on the pricing for that client, again, has its attendant benefits for us. Yeah, with the spend that we have in this segment, and the spend that we have with the OEMs in this segment, we see significant opportunities for value creation. That is part of the CAD 150 million of opportunities that we've identified. Yeah.
One of the things I always really liked about the ABS funding was it effectively paid the banks to warehouse before it going to ABS. If the ABS demand wasn't there, that kind of acted as a safety valve as well.
Yes.
You were paying a standby fee.
Yes.
I'm curious about if it would work the same way with the syndications at point of any given quarter once the liquidity dries up and communication advances.
In addition to the senior line that provides that type of backstop capability to us, we're in the process of setting up a warehousing facility that will act the same way. As we accept orders that we would envision syndicating, we would have that standby that would provide a backstop. As we're drafted by the OEMs and need to actually draw funds, we would draw from that warehouse facility, and that would carry us through to the ultimate billing and syndication to the client. Our typical arrangements are that we're compensated for those whole periods. I won't say stay harmless, but we receive interest incomes throughout the period in which we're out of pocket until at a point in time where we're actually billing the client by way of the lease.
A follow-on question to that. As your use of ABS decreases as a result, are there some kind of cost savings associated with reducing the use of ABS?
Potentially. I haven't dug into that with Kieran at this point in large measure because, again, we're still going to be driving significant volumes through that. The ABS program's still going to be a very large source of funding for the organization. Jeff, let us take that one away, and just follow up. Yeah.
To what extent was your drive to deleverage just predicated on the fact that rating agencies have, for you guys in particular, a tangible leverage calculation versus a lot of other net interest margins companies do not have a tangible leverage calculation. I mean, effectively, your secured borrowings are AAA type paper.
Yeah.
Secured borrowings for a bank would be deposits.
Right.
If we did a tangible leverage for the bank under that thing, it'd blow way through this thing. Help me square that. Are you doing this because the rating agencies say That don't cover a lot of fleet management companies at all.
Right.
They've got that box for whatever known reason. Now you're just kind of having to drive your truck through that box. Do you see my point?
There is a degree of reality to that, Tom, yes. To your point, there's not many of us, and they have developed a view. While I'd like to think that in time we'll be able to alter that view, at this particular point in time, we need to be compliant with that view. Part of the direction that we're signaling to you in terms of a sub six times tangible leverage ratio is, again, a output of the analysis that we've done that says if we're going to be able to secure a Moody's or an S&P rating, we need that number, and that kind of translates into a sub six tangible leverage number. I'm conscious that we've gone well over time, but we're happy to stay here in the room for as long as necessary.
If people feel they have other commitments, I don't want anybody to feel badly we're getting going. We're also here to answer questions for as long as you like. I just want to make that known. If there are any other questions, happy to answer them otherwise we'll. Okay. Thank you very much.
Ladies and gentlemen, before you disconnect, if any of you missed the announcement before the call got underway, there was a miscommunication regarding the webcast URL for this meeting. The one that was circulated was the webcast from this morning's Q1 call. The two links are very similar. What you could do is simply insert the word update before 2019 0508, and that will take you to the webcast of this call. It will take us about an hour or so before that archive is available, though. Thank you for your attendance. Bye for now.