Computershare: Result 2014

Computershare has chalked up its sixth consecutive half of earnings growth – since the 20% fall in the first half of 2012 – with a slight improvement in market conditions overcoming drags caused by low interest rates on client balances and the stronger US dollar. Overall, management's measure of underlying earnings per share (EPS) rose 9.8% to US$0.602 in the year to June, at the top of guidance for 5–10% growth.

The full-year result was struck on flat operating revenues of $2,023m, and reflected a 2% fall in operating costs (adding depreciation to management’s measure) to $1,520m. Both numbers were reduced, however, by the rise in the US dollar, the company’s reporting currency, which meant that non-US revenues and costs were diminished upon translation. In constant currency terms, revenues would have grown 3% and costs would have risen 1%.

Management’s view of earnings before interest, tax, depreciation and amortisation was $541m, up 6.0%, or 6.7% in constant currencies. Depreciation was about $38m, to give an underlying operating profit of $503m, up 7%.

Computershare is the leading global provider of equity investor record-keeping services and employee stock plan administration, with leading positions in all major markets. This gives it an advantage over its more fragmented competition because it can spread its technology costs and know-how across a larger stream of revenue.

Over the long-term, we’d expect earnings to increase slightly more quickly than economic growth – in the high single digits – but in the short term the company’s fortunes are tied to activity in investment markets.

Of particular importance is merger and acquisition activity, which is showing signs of stirring after the recent lull. Indeed no lesser authority than GMO’s Jeremy Grantham recently predicted a ‘veritable explosion [in M&A deals] to levels never seen before’. (you’ll need to register to follow the link, but it’s well worth it and free).

Grantham was talking about the US mainly, but Computershare is now in pole position to benefit from increased activity in that market with its 2011 acquisition of the US Shareowner Services business now successfully bedded down. Cost savings of $76m from the deal have so far been achieved and a final $4m is expected in 2015. It’s comforting to know that new chief executive Stuart Irving comes fresh from leading the ‘technical and operational integration’ of that company-changing acquisition.

Another major driver of Computershare’s profitability is the interest it earns on client cash balances, much of which it gets to keep for itself according to the terms of client agreements. This interest is, in turn, impacted by the level of client balances and interest rates. The balances tend to be quite volatile, but have stayed fairly steady around the $14bn for the past three half-years. The interest earned on that balance, however, dropped from around $105m to $87m in the second half of 2014 as interest rates continued to fall. At some stage interest rates will rise and Computershare will benefit considerably; that still looks a long way off, but we’re patient investors.

Strong cash flow

Free cash flow rose 35% to $393m, thanks to the profit increase and a 60% fall in capital expenditure to $20m. The company finished the year with net debt of $1,199m (down from $1,257m a year earlier), which is more than we’d like but nevertheless comfortable given that the interest bill is covered eight times by the underlying operating profit.

A final dividend of A$0.15 was declared (20% franked, ex date 19 Aug), up from A$0.14 in the first half and the first increase in four years. The full-year dividend of 29 cents gives a payout ratio of just under 50% and a dividend yield of 2.4%.

The stock is down 5% since Computershare's UK voucher business to be wound down on 30 Jul 14 (Hold – $12.80), most of it following today's result, which probably reflects the guidance for underlying earnings per share to rise only 5% in 2015 due to ‘lower yields on client balances and some short-term headwinds’. We suspect that this is conservative, but it would give about US$0.63, or A$0.68 at the current exchange rate of 0.93, and a prospective PER of 18. That’s attractive for such a high-quality business with steady growth prospects, but we’d want to see a slightly cheaper price before buying. HOLD.

Note: Our model Growth and Income portfolios own shares in Computershare.