IRESS: Result 2012

IRESS’s full-year result failed to impress. Net profit fell 9% to $54.4m, from slightly higher revenue of $206.7m. However, excluding the amortisation on sunk software development costs, earnings before interest tax and amortisation (EBITA) was down only 2% at $60.1m. A 24.5 cent final dividend was declared, bringing the annual total to 38 cents (90% franked, ex date 5 March).

In 2010 we upgraded IRESS due to its excellent cash generation and on the basis that its dominant position at home and planned overseas expansion would lead to further earnings and dividend growth. Nearly three years on, the share price is down slightly (although dividends would mean investors are slightly ahead). Earnings and dividends have similarly been flat.

These are hard times for a company that's used to generating 15%-plus growth, so what, if anything, has fundamentally changed?

Australian business steady

Table 1 presents a numerical overview. The core Australian financial market data business has been steady. That’s no surprise: the finance industry has been laying off staff, making it hard to maintain the number of licences, let alone increase prices. And with IRESS commanding the majority of the market, we were never expecting outstanding growth. Modest growth is still possible but is dependent on a pick-up in equity markets. Judging from ASX’s recent result we may be headed that way.

Its newer wealth management business has continued to have success, winning new clients and increasing profit, which rose 15% for the year just ended. Here an increasingly complex regulatory environment and lack of other options is helping IRESS. We’d expect this division to continue to grow revenue and profits in the mid-single digits.

If we’ve overestimated IRESS’s abilities, it hasn’t been on the home front.

Canucks drag on performance

Overseas, however, it hasn’t been smooth sailing. The company's expansion into Canada has proved more difficult than expected, and the full-year result extended the frustration expressed half-way through the year. For the full year, profits fell 23% to $6.2m.

Its single-product focus in Canada makes the division vulnerable to demand fluctuations from sell-side brokers. Competition has been tough, as larger operators such as ThomsonReuters undercut IRESS’s pricing. A weak equity market hasn’t helped either. This has made winning large clients difficult, and hampered growth. Longer term, management plans to expand its offering in Canada to make it less reliant on sell-side brokers.

South Africa too, has presented mixed results. There it sells wealth management software and, since 2011, financial market data, thanks to its acquisition of Peresys. Its wealth management business suffered over the past year with profit falling 31%. The financial data business, though, continues to perform strongly, with profit up 6% in 2012 – although it wasn't enough to offset the losses in wealth management. South Africa’s market is significantly smaller than Australia's, but here too we see significant potential for growth.

UK opportunity

IRESS has also expanded into Asia and the UK. These are both long-term projects.

Three years in, its Asian business is still making losses. It’s hard to gauge the potential for success in Asia, but there’s no obvious reason why IRESS shouldn’t be able to turn a profit from the region. Management has also capped total investment in Asia at $4m per year, which is a prudent approach to expansion.

The UK expansion is a more recent development and presents a significant opportunity – with a potential market for wealth management software twice that of Australia. It's a sensible move, and fits management's measured approach to expansion. It's early days but we can see this division contributing meaningfully to future profits. It recently signed Towry – a medium-sized financial advisor – as a client, which bodes well for the division's progress. Over time, the UK business could grow to equal that of the Australian wealth management arm.  

Quality remains, growth more subdued

At home, IRESS has a stable financial markets business, coupled with a growing wealth management division. Elsewhere it’s proved tougher to bank profits than we expected, but we still expect decent growth from this business: somewhere in the order to 5%-10% a year in a more buoyant equity market environment.

IRESS remains an above-average business that’d we’d buy at the right price. For now, though, with the share price up 14% since our update on the interim result on 27 Aug 12 (Hold – $7.11) we’re happy to bide our time. HOLD.