Gentrack: Interim result 2015
Recommendation
For most companies, losing a customer is a sign of weakness. But for billing software maker Gentrack, the recent loss of Contact Energy shows off its most significant competitive advantage.
First, a bit of history: Origin Energy bought a 52% share of Contact Energy, a New Zealand-based electricity retailer, back in 2004. In 2008 Origin started overhauling many of the company's internal systems to boost productivity, including the installation of SAP's enterprise application software, which manages everything from the call centre to billing and HR.
At the time, Contact was using Gentrack software to measure usage, send out bills and collect payments. As Contact would soon realise, though, switching billing software providers isn't as simple as uninstalling an app on your iPhone – it took six years for the company to completely turn off Gentrack's software after the initial announcement was made.
Key Points
Gentrack has captive customers
Contract timing casues earnings to be lumpy
Close to upgrade
That's the thing about billing software. It manages a company's cash flow and needs to be rock solid and reliable. Contact Energy has half a million customers; if there's a billing error it could face a deluge of complaints, not to mention that its cash flow might temporarily dry up.
What's more, it took years to build the new integrated billing system and cost Contact $80m to install it. The high cost of switching providers and the potential for a public relations disaster means that once Gentrack's software is installed, company executives are very reluctant to fiddle. It's no surprise then that more than 90% of the customers Gentrack had five years ago remain with the company today. Billing software has one of the lowest churn rates of any industry.
This gives Gentrack significant negotiating power when it comes to pricing – which accounts for its operating margin of 30% – but it also means that new customers push hard during the initial contract negotiation, before they're locked in.
Interim result
Management said the company is likely to miss its prospectus forecast for full-year revenue of NZ$44.7m and earnings before interest, tax, depreciation and amortisation (EBITDA) of NZ$15.5m. This is due to the negotiation of two new contracts taking longer than expected, despite being in 'the final stages'.
The two contracts are worth around NZ$2.5m in revenue, or 5.6% of total. The stock has fallen 8% since the news but we're not concerned. If it is just a matter of whether revenue is recognised this half-year or next, as management suggest, the delay has no impact on the company's long-term prospects.
Management said: 'If progress can be made on these contracts and other licence transactions under
 negotiation the prospectus forecast remains a realistic outcome … A strong prospect list continues to support Gentrack's confidence in future growth beyond FY15'.
Total revenue for the six months to 31 March was NZ$18.5m, up 4%. Underlying EBITDA came to $5.5m, unchanged from the prior corresponding period, due to an increase in capital expenditure in preparation for the two new contracts mentioned above.
The company added several new customers, especially to its Airport 20/20 airport operating system, which covers several functions such as aeronautical billing, flight information displays and baggage management.
'We're pleased to sign new airports customers Glasgow, Aberdeen and Southampton Airport Group, and Queenstown Airport,' said chairman John Clifford. Only around 15% of Gentrack's revenue is from the airports business, though management expects it to be a significant source of growth for the company due to a worldwide trend towards privatisation.
Close to upgrade
If the two new contracts materialise before the company's books close, management expects Gentrack to earn a net profit of NZ$9.3m, or 12.8 NZ cents per share, for 2015 with free cash flow being roughly the same. That puts the stock on a forward price-earnings ratio of 17 and a free cash flow yield of around 5.8%. The board is targeting a payout ratio of 70–80% for a dividend yield of around 4%.
Over time, we expect the company to achieve overall growth of around 4–6% a year, with Gentrack benefiting from a worldwide trend towards privatising and deregulating utilities. This result is a reminder that, despite having captive customers and highly recurring revenue, large customers and the timing of contracts can make earnings relatively more volatile than larger competitor Hansen Technologies.
The stock has fallen 14% since Gentrack: Like Hansen, only cheaper from 7 Apr 15 (Hold – $2.35) and is hovering just above our recommended Buy price of $2.00. With no debt, stable recurring revenues, a 5.8% free cash flow yield and reasonable growth prospects, it might make sense to start building a position around current prices. For now, though, our official recommendation remains HOLD.
Note 1: Our model Growth and Income portfolios own shares in Hansen Technologies.
Note 2: With several substantial shareholders, Gentrack's stock is highly illiquid with a large spread between the bid and offer prices. To ensure you aren't caught overpaying, it's important your purchase orders have a limit price and are not made 'At Market'.
Disclosure: The author owns shares in Hansen Technologies.