Gentrack: Result 2017

At Gentrack's 2016 annual result, management said ‘We enter 2017 with a solid pipeline of opportunities and expect to continue to deliver long term revenue and EBITDA growth of 10% '. Gentrack's full-year result shows the understated accuracy of that forecast.

Revenue increased 43% to NZ$75.2m for the year to September, while earnings before interest, tax, depreciation and amortisation (EBITDA) rose 43% to NZ$23.9m – a further 4% can be added to both those figures after removing the effect of currency fluctuations.

Even excluding acquisitions, revenue growth was still up 18% and EBITDA was up 24%. So much for being a boring, slow-growth billing software maker.

Most of the growth came from project services. However, these one-off software projects for customers are mostly discretionary. Project services revenue tends to be lumpy so the 36% increase this year isn't something you can count on indefinitely. But who's complaining.

When a utility chooses a billing provider, it isn't going anywhere without significant risk once the software is installed. High switching costs mean the decision to switch providers isn't taken lightly, and that gives Gentrack negotiating power when it comes to renewing contracts.

You can see this at work in the 42% increase in sales from recurring annual fees and support services, which together account for around 57% of revenue. Now, a lot of that growth is from three recent acquisitions – Junifer, BLIP, and CA Plus – but, with overall organic revenue growth of 18%, a back-of-the-envelope calculation still suggests organic growth of at least 8% for annual fees and support. When we upgraded Gentrack to Buy on 11 Aug 15 (Buy – $1.80), our valuation assumed growth of 4–6% for this division; 8% is impressive.  

Contracted price rises usually aren't more than a few percent a year, so the difference has come from adding customers – no easy feat in this industry, where the high switching costs mentioned earlier mean that potential customers are just as unlikely to leave competitors, such as Hansen Technologies, as they are to leave Gentrack.

Nonetheless, Gentrack signed up 12 new utility customers and now serves around 41% of all energy utilities in its three main markets – Australia, New Zealand, and the UK – making it the largest billing software provider in New Zealand, and second-largest in Australia and the UK.

Airports take off

Growth continued at Gentrack's airport division, which makes operating systems that manage aeronautical billing, flight information displays and baggage handling. The company added nine new airports to its software platform during the year, including Abu Dhabi, one of the busiest airports in the world. Gentrack now serves 20% of the top 100 airports worldwide, and its software is installed at 85% of Australia and New Zealand's airports.

Revenue from the division grew 44% during the year to NZ$11.7m, though almost all of this was due to the acquisitions of BLIP and CA Plus. Excluding acquisitions, revenue rose a modest 3% or so.

The airport software industry is more competitive than billing software and Gentrack is still a small fish. As such, the airport division has a lower EBITDA margin than the utilities business – 27% compared to 33% – but that may soon change.

The company's Airport 20/20 software is relatively ‘off the shelf' compared to its customised utility billing software. This means revenue can increase faster than costs as the company can sell its product to a growing number of customers without needing to increase the number of software developers.

While acquisitions accounted for the bulk of revenue growth, they only added 10% to EBITDA – the stunning 60% increase in Airport EBITDA was mainly down to lower operating expenses and almost all of the incremental revenue from existing customers falling to the bottom line. As this division grows, we expect margins to continue to expand.

What's in an ‘A'

When Gentrack reports its results, it discloses net profit after tax (NPAT) – revenue, less all the company's expenses and taxes. This year, Gentrack's net profit rose 23% to NZ$11.8m.

Now, for most companies, that's all there is to it. Gentrack, however, also reports something it calls NPATA (net profit after tax adjusted for amortisation). When a management team starts reporting vague, adjusted profit figures we usually raise an eyebrow – it's often more about sugar-coating than full disclosure. But, in Gentrack's case, if you want to get the best idea of the company's underlying earning power, NPATA is the figure to pay attention to.

In 2012, Gentrack reorganised its corporate structure, with the Australian subsidiary buying the parent company, Talgentra Pacific Group. Accounting rules meant that a big slab of goodwill and intangible assets were added to the balance sheet, even though the manoeuvre didn't affect operations in any way.

Intangibles, however, are amortised through the income statement as an expense. In 2017, Gentrack's NZ$11.8m net profit was calculated after expensing NZ$3.3m of non-cash amortisation charges related to purchased intangibles, so we need to add back NZ$2.5m (after-tax) to reach Gentrack's underlying net profit of NZ$14.3m – which was up a hearty 29% on 2016. This is the figure the board uses to calculate dividends and is a closer approximation of the company's free cash flow than net profit.

Until now, management has said it expects revenue and earnings to increase at 10% over the long term. This year, the tune changed. Ongoing energy and water deregulation in Australia, the UK and Singapore is providing an expanding number of start-up retail utilities in need of billing software. Management has increased its long-term target for earnings growth to 15% a year.

Gentrack has far exceeded our expectations, more than tripling in a bit over two years since we first upgraded it at $1.80 in Gentrack cleared for takeoff. We're increasing our price guide and happy to hold for the long term. Nonetheless, with a price-earnings ratio of 24 based on consensus estimates for 2018 earnings, Gentrack is a long way from being the bargain it once was.

Good result aside, we're mindful that Gentrack is still a small software company with just NZ$75m of revenue. We see nothing specific on the horizon to raise concern, but small software companies have a history of catching investors off-guard. To better align Gentrack and Hansen with companies of a similar size and risk profile, we're therefore notching up their risk ratings. However, we're also increasing Gentrack's recommended maximum portfolio weighting from 3% to 4%. If it has risen beyond this, we'd recommend reducing the holding in favour of the better opportunities on our Buy list. That said, this was another excellent result and we're happy to HOLD.

Note: 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 buy and sell orders have a limit price and are not made ‘At Market'. 

Disclosure: The author owns shares in Gentrack.