Computershare: Result 2018

At its interim result in February, Computershare management told the market it expected to increase earnings per share by 12.5% for 2018 ‘with a positive bias'. It duly delivered on that last week by reporting growth of 14.1% in constant currency terms, or 17% to 63.2 cents including the benefit of currency movements.

So much so good, but it then disappointed by guiding towards growth of 10% for 2019, when the market had been hoping for something like 13%. The stock went up anyhow, which perhaps shows that investors are expecting further upgrades.

We wouldn't argue either way. Instead we prefer to look further out, and here we see trouble due to the increasing reliance on lower-quality earnings mortgage servicing.

In 2018, mortgage servicing accounted for just over two-thirds of Computershare's earnings growth, taking it from 14% to 20% of earnings before interest, tax, depreciation and amortisation (EBITDA).

It's a far more competitive than Computershare's core share registry business, there are few obvious competitive advantages, other than scale, and Computershare is a relatively small player. To make matters worse, mortgages get repaid over time, so you have to keep winning new business.

This is particularly an issue in the UK, where the large UK Asset Resolution (UKAR) contract will see earnings peak in 2019. Computershare has won a number of contracts with the UK's second-tier banks, which it expects to bring new business to replace the winding down of UKAR. Management reiterated its expectation of ‘positive organic growth' in the UK mortgage book from 2020, but it remains a business where you have to run hard just to stand still.

Elsewhere the company saw a 26% increase in Corporate Actions revenue (all figures in constant currency terms), rebounding from multi-year lows thanks to some large deals in the US, including MetLife's spin-off of Brighthouse Financial. The outlook given by management, however, is for revenue from corporate actions in the current year (excluding interest on client cash balances, aka margin income) to ‘be more subdued' than in 2018.

Combined with flat Register Maintenance revenues, this gave a 4% increase for Register Maintenance and Corporate Actions revenue, but a 10% increase in EBITDA due to the latter's higher margins.

Revenue from Employee Share Plans held flat, despite the boost from Brexit experienced in the previous year, but EBITDA fell 7% due to cost investment.

Overall, operating costs rose 4%, behind the 6% revenue increase and thereby leading to a 13% increase in group EBITDA.

The company could see a further boost to earnings from increased margin income due to higher interest rates and/or from a further recovery in corporate activity. However, we remain wary of the shift towards mortgage servicing.

Guidance for 2019 implies earnings of about 70 US cents, or 95 Aussie cents at current exchange rates. The stock is currently trading at about 20 times that, which puts it near the top of our valuation range. That said, we were probably a bit hasty in downgrading to Sell back in December and we're raising our price guide, with the Buy price going from $12 to $13 and the Sell price going from $17 to $20. As a result, our recommendation shifts back to HOLD.