Computershare: Global leader on sale
Recommendation
The theory is simple enough. Buy the highest quality companies in tough times when their stock is cheap. The practice is altogether different: Only a very few manage to outperform the index.
This gulf is partly explained by the fact that what looks cheap often isn’t and what is cheap is usually well camouflaged.
Share registry giant Computershare likely falls into the latter category. We think it’s cheap, perhaps even a bargain, although there’s nothing certain about it.
Key Points
- Computershare’s earnings dented by low interest rates and subdued corporate activity
- If these factors ‘normalise’, the stock will look much cheaper than it does today
- It’s a high quality business selling for a cheap price
In early 2009, the share price of travel group Flight Centre fell below $3.50, down more than 85%. Investors were concerned its business was losing relevance, rather than facing a cyclical downturn.
In 2005/06 four-wheel drive accessory company ARB Corporation suffered a share price fall from above $4 per share to below $3, with rising oil prices threatening four wheel drive sales. In 2004, hearing implant leader Cochlear fell below $20 under the threat of legal action by the US Department of Justice that could destroy its business.
Wall of worry
These are examples of great businesses suffering through ultimately temporary difficulties. Each occasion provoked an upgrade to an outright Buy at close to their share price nadir. With subsequent returns in the hundreds of percent, all have been extremely profitable. And yet at the time, these recommendations provoked significant consternation.
The same can be said of Computershare right now. And we should acknowledge the possibility of being wrong. The point, though, is this: Even the most prescient of calls won’t look like a sure thing at the time because it is the perceived risk that creates the opportunity.
In Computershare’s case, typical current concerns are listed in table 1 (simply click on the link to see our response to each of them). None of these are causing this analyst any sleepless nights. What they are doing is creating an opportunity to buy a great business at a good price.
These concerns seem more pressing given that underlying earnings per share has fallen from US57.8 cents in 2010 to US49.1 cents in 2012. The more cyclical and profitable parts of its business have been crunched. As with Cochlear, ARB Corporation and Flight Centre in previous years, investors are asking whether the hoped-for cyclical boost will ever happen or whether this is a more lasting erosion of its business.
For our money, the evidence suggests that this is a tough cyclical downturn only. Computershare is not losing customers. Indeed, market share has been increasing. Customers remain incredibly sticky (see Computershare – how big is its moat? and the comments section for more on why) and the company continues to add global market share, predominately through acquisition.
Look at the US operations, for example. In the mid-2000s, there were three major players in the US share registrar market with a market share of roughly 20-30% each. Computershare now owns all three, suggesting its market share in the US registrar business is over 60%. It’s five times the size of its nearest remaining competitor in that market.
Why then is profit contracting? Because individual customers are cutting activity.
Mergers and acquisitions, floats and secondary market offerings generate some of Computershare’s highest margin business in the good times. But in 2012 revenue from these so-called corporate actions fell US$23m to US$156m from already depressed levels. It’s the lowest revenue from this area since 2004, when Computershare was about half its current size. Competitors aren’t taking Computershare’s business; there just isn’t the same level of business to go around at the moment.
Awaiting turnaround
This is likely a cyclical rather than a structural problem. If anything, important structural growth is being masked by the cyclical downturn. When corporate activity levels eventually return, Computershare is likely to profit handsomely. In the meantime other parts of its business, particularly register maintenance, continue to generate reliable recurring earnings that underpin our investment.
With EPS down 15% in two years, we think many investors are mistaking a cyclical downturn for something more permanent—and questioning whether Computershare still deserves a ‘great business’ tag.
Certain statistics only add to these concerns. Earnings before interest and tax margins in 2012, although a still impressive 25%, were down from 32% in 2010. As a result, return on equity has fallen from a whopping 30% in 2010 to 23% in 2012. On this basis, Computershare looks like a good business rather than an excellent one.
2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | |
---|---|---|---|---|---|---|---|
Revenue (US$m) | 1,198.3 | 1,404.2 | 1,564.0 | 1,495.8 | 1,599.6 | 1,618.6 | 1,840.8 |
EBITDA (US$m) | 240.0 | 370.5 | 479.2 | 475.5 | 510.9 | 493.6 | 459.0 |
EBITDA margin (%) | 20.0 | 26.4 | 30.6 | 31.8 | 31.9 | 30.5 | 25.2 |
Net profit (US$m) | 135.5 | 219.4 | 290.4 | 289.5 | 321.2 | 309.3 | 272.8 |
Management EPS (US cents) | 22.7 | 36.7 | 51.6 | 52.1 | 57.8 | 55.7 | 49.1 |
A$ EPS (at A$1=US$1.035) | 21.9 | 35.5 | 49.9 | 50.3 | 55.8 | 53.8 | 47.4 |
PER (x) | 39.1 | 24.1 | 17.2 | 17.0 | 15.4 | 15.9 | 18.1 |
Dividend (Aust. cents) | 13.0 | 17.0 | 19.0 | 22.0 | 25.0 | 28.0 | 28.0 |
Yield (%) | 1.5 | 2.0 | 2.2 | 2.6 | 2.9 | 3.3 | 3.3 |
On top of this, there’s the issue that genuinely good opportunities are often well camouflaged. As with ARB Corporation in 2005 or Cochlear in 2004, Computershare doesn’t look superficially cheap. The stock currently trades on a historic price earnings ratio (PER) of 18 times and a partly franked yield of 3.3%.
Investors could easily dismiss the opportunity with a ‘Computershare has got problems and it’s trading at 18 times earnings’ attitude. One needs to use a little foresight to see its current cheapness.
Barring a further downturn in business or substantial changes in exchange rates, management has forecast 2013 earnings per share growth of 10-15%. This growth isn’t because of a great turnaround in the more cyclical parts of the business, which remain subdued. Recent acquisitions are the main factor. The three acquisitions made in 2011 are likely to contribute US 5 cents or more to EPS in 2013.
If management’s forecast of 10-15% EPS growth is met, without any major turnaround the forecast PER drops to 16. There’s likely more to come.
Growth opportunities
Substantial upside remains in integrating recent acquisitions, particularly the BNY Mellon shareowner services business. BNY Mellon will transform Computershare’s US business. Further down the track, with exciting cross-selling opportunities and a chance to modernise America’s archaic share registrar industry, there could be far more value to be extracted.
But, in the interest of conservatism, let’s assume management’s current 2013 forecast already includes most of the benefit of the BNY Mellon acquisition and leave the rest as blue sky.
So investors are buying Computershare for 16 times next year’s earnings. But a big part of the business is currently limping. What would happen if 2013 was more ‘normal’?
It’s easy to imagine how even a return to average levels of corporate activity might add another US5-10 cents to annual earnings per share from the existing assets alone (see Computershare takes the lion’s share – pt 2). A return to boom times would see a much bigger boost.
Then there is the matter of interest rates. Computershare stands to collect more interest on about one-third of its massive pile of customer cash, which averaged US$15.4bn in the second half of 2012, if interest rates rise above their current historic lows. The bulk of that unhedged customer cash sits in the UK, US and Canada currently earning a minuscule average of roughly 0.5%. Rates are unlikely to stay that low indefinitely.
Every 1% rise in interest the company receives on, say $5.0bn of that cash pile, adds about US 6 cents to annual earnings per share. If very high interest rates were to return, Computershare would benefit greatly at a time when other stocks in your portfolio would be suffering.
But we don’t need to get excitable to make an interesting investment case. Adding US 5-10 cents for increased corporate activity and another US 6 cents (representing just a 1% increase on the company’s cash pile) to management's forecast for this year brings ‘normalised’ EPS for 2013 to US65-72.5 cents (A62.8-70.0 cents), or a PER of 12-14.
As with most value investing buy ideas, there are valid reasons for pessimism. But Computershare is the only truly global share registry business, is many multiples the size of its nearest competitor and has 50-70% market shares in its key markets.
By using conservative assumptions to anticipate what it might look like mid cycle, rather than in the current environment, a PER of 12-14 is cheap for a business of Computershare’s long term growth track record, high returns on capital and significant and sustainable competitive advantage. If corporate activity spiked or interest rates rose further, or the Australian dollar collapsed, it would look cheaper still.
That’s why Computershare is a very high quality stock trading at an attractive price. And were it to fall another 15% or so, it would be a clear bargain and we'd upgrade once again to an outright Buy (see recommendation guide). Right now, it remains a LONG TERM BUY and a great bedrock stock for most portfolios.
Note: The model Growth and Income portfolios own Computershare.