Seek peak shows growth ahead

Despite the doom and gloom forecast for this reporting season, there have been some exceptional performers.

Two stand-outs are Seek (ASX: SEK) and The Reject Shop, which both reported solid results. The Reject Shop grew profits by 9% and Seek’s earnings per share grew by 12% during the half. Since their lows in June and August respectively, The Reject Shop’s share price has risen 89.5% and Seek’s by 68.6%.

And while other companies in which I have holdings such as Carsales (14% NPAT growth), Webjet (25% EPS growth), Cash Converters (10%), Credit Corp (11%), CSL (30%), have all met or exceeded expectations, it is Seek that I would like to focus on.

I have applied Warren Buffett’s “look-through” concept, where earnings include the profits that a company pays to its shareholders in the form of dividends and the retained earnings that the company uses to expand its operations. The focus of the concept is that all profits benefit shareholders in one way or the other, whether they are paid out as cash dividends immediately or invested back into the company to expand operations (which will increase the share price over time).

In the latest period, Seek’s look-through revenue rose 8% to $326.7 million from $302.6 million. Look-through earnings before interest, tax and depreciation (EBITDA) rose 12% to $120.5 million from $107.6 million, and net profit after tax increased 11% to $67.5 million from $60.6 million.

Of great interest was the fact that EBITDA for the domestic job search business was flat at $75.3 million. The domestic economy was such that Seek saw a double-digit volume decline in the number of ads placed on its site, and anyone who was looking at these internet list businesses during the GFC would know that the volume of ads can dry up very quickly if the economy turns and recover equally as quickly.

The flat EBITDA result for the domestic business, however, demonstrates that the detrimental impact from volume declines were offset by both price increases and cost control. I also liked the 108% growth in look-through EBITDA of the Seek Education business to $22 million from $10.6 million, and the 6% growth in Seek International look-through EBITDA to $23.2 million from $21.8 million.

I believe the structural migration to online platforms still has some way to go, with an estimated 61% of job advertisements now online. This will ultimately be much higher and the trend should put some support under Seek’s prospects – nothwithstanding the economic and business cycles.

The international business grew impressively, with revenue up by 18%, but it appears the company is expensing its investment because profit was impacted by lower margins. Management said it was “investing aggressively” to ensure the long-term return from international businesses, but there was only $800,000 of capex reported for International in the first half.

The other changes that impressed was the modest improvement in the company’s balance sheet, with net debt down 10% to $203.9 million, net debt to EBITDA down to 1.9x from 2.2x, and net interest cover up to 10.7x from 8.6x.

Seek has indicated that it expects the second half to be better than the first half, and when management was pressed for detail they indicated high single digits with revenue and EBITDA from the domestic business to be below the first half, which would be offset by growth in international and education.

It’s not uncommon for analysts to fail to see the wood for the trees during reporting season and it is easy, as an investor, to look at the slowdown in the domestic business and call the business mature. I believe, however, that Seek will not only benefit from a cyclical turnaround in the economy at some stage but that it remains uniquely positioned to take advantage of the uncompleted migration of jobs advertising online.

Investors should also benefit from a stable competitive landscape. While the outlook for competition is always dynamic, I have not seen any significant change from the entry of business website LinkedIn, for example, and don’t expect any dramatic shifts in the short term.

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It is not easy to get a true future value for Seek (see Figure 1) because of its consolidated accounting and meaningful changes in return on equity and equity after acquisitions are made. However one view is that the market value of the international businesses (if realised) is materially higher than the valuations booked to the balance sheet.

I have long believed that the company’s investment in the number 2 Chinese job search site, Zhaopin, would be worth materially more than the book value if floated to an enthusiastic Nasdaq audience. And it now appears I will find out if I am right. Seek has indicated that it will float the business before the end of the year, making it reportedly one of only two listed Australian companies to own an overseas-listed entity. The structure of the sale and how much of the proceeds are reinvested and compounded at high rates of return, however, will ultimately determine the long-term returns to Seek shareholders.

As Figure 1 demonstrates, the last clear buying opportunity was in mid-2012 and the more recent 15% jump in the share price last week has pushed market valuations just above the forecasts I have for future intrinsic valuations for Seek. But only just.

Any fears of the Federal Reserve pulling the rug from round three of Quantitative Easing could see the share price fall sufficiently back into value again and provide a compelling case to add Seek to your portfolio.

Roger Montgomery is the chief investment officer at Montgomery Investment Management. If you would like the opportunity to discuss your portfolio and investment options with Roger or his team simply email office@montinvest.com.