Computershare: Interim result 2019

Computershare has an unusual revenue model, making anywhere from about 6% to 12% of its revenue from the interest it gets on cash it holds on behalf of clients - so-called 'margin income'. Due to the relatively fixed nature of its cost base, that can translate into anywhere from about a quarter to a half of its profits.

It ebbs and flows according to the amount of funds held and the interest rates earned - and for it to really sing, you need both to line up.

That's what happened in the six months to December, with client balances rising 21% to $21bn from a year earlier, and an average annualised yield of 1.6% on the interest-exposed balances (about $12.9bn of it, up from $11.0bn). That compares to a lowly 0.9% earned in the prior period and reflects higher interest rates in the US, UK and Canada.

The result was a 57% increase in margin income to $125m. It has now almost doubled since the $67m earned in the first half of the 2017 financial year, when client balances were only $16.6bn and the yield was just 0.8%.

Almost all the margin income comes from Computershare's largest two divisions: Register Maintenance and Corporate Actions and Business Services (mostly comprised of mortgage services and class actions). As a result, these two businesses increased underlying earnings before interest, tax, depreciation and amortisation (EBITDA) by 16% and 6% respectively.

Guidance upgraded

Helped also by lower costs and a reduced tax rate, underlying earnings per share (EPS) rose 17% for the half (ignoring the effects of currency movements) and full-year guidance was upgraded to growth in underlying EPS growth of 12.5%, up from 10%.

Without the margin income, though, underlying EBITDA actually fell 2% in the half, mainly due to a 4% fall in Register Maintenance and Corporate Actions and a 17% fall in Business Services. Both these falls reflected the absence of large events in the prior half: the demerger of Brighthouse Financial for Corporate Actions and the Volkswagen class action for Business Services. The latter resulted in a 27% fall in class actions revenue and offset a 9% rise in Mortgage Servicing revenue.

Mortgage servicing continues to do well, with EBITDA rising 6% to $60m. The US business added a big chunk of mortgages late in the period, which pushed unpaid balances up 14% to $92bn. However, the revenues from this weren't fully reflected in the result for the half, while there were significant upfront costs - so revenues and margins for this business should have a following wind in the second half.

In the UK, the transfer of the UK Asset Resolution (UKAR) portfolio onto Computershare's platform continues to plan and should be completed by June.

Mortgage worries

However, we continue worry about the competitive nature of mortgage servicing, Computershare's lack of a clear edge and the constant need to win new business. The company has won some work from the UK's challenger banks, for example, but it's not clear if it will be enough to offset the hole that will begin to open up after UKAR earnings peak this year.

So margin income was the clear highlight of this result but, with management expecting client balances to fall in the second half and the prospect for further interest rate rises receding, the more conventional sources of revenue will need to pick up the slack. Here we see risks, particularly given the shift in business mix towards mortgage servicing.

Guidance for growth of 12.5% implies about 70 US cents of underlying EPS for the full year, or about 98 Aussie cents at current exchange rates. That puts the stock on a price-earnings ratio of 19, which looks fair. We're nudging our Buy price up slightly, from $13 to $14, but keeping our Sell price at $20 and nudging down our maximum recommended portfolio limit to 6%. HOLD.