OFX Group: Result 2017

You could feel the surge of relief on Tuesday, when shares in OFX Group rose 17% following its 2017 result.

It was not without justification. The company has been accident-prone over the past few years since listing, and new chief executives have a reputation for resetting expectations with weak results.

As it was, the underlying earnings before tax, depreciation and amortization (EBTDA*) of $27.8m (down 23%) was on the weaker side of the guidance given in February's profit warning for $27.5m–28.5m, while the underlying net profit of $19.6m (down 18%) was arguably on the stronger side of guidance for at least $19.0m.

The net profit line was helped by a big fall in the overall tax rate to 18% (from 31%), thanks to a research and development tax credit and the reclassification of an overseas subsidiary as an offshore banking unit, entitling it to a tax rate of just 10%. We'd expect to see a tax rate of 22–25% on an ongoing basis.

Fall in transaction values

Total transactions rose 9% to 852,000, just shy of the 12% increase in 2016. However, as flagged in the February profit warning, the average transaction value fell 9% to $22,800, due to sterling's fall following Brexit and ‘uncertainty in global markets throughout the year'. The first part of that excuse is entirely fair, but the second part less so – markets don't feel like they've been any more uncertain than usual.

Somewhat concerning is management's expectation that the contribution from Europe is likely to decrease slightly in 2018, with the competitive nature of the market making growth in active clients ‘more challenging, and a full year impact from the lower pound.

The North American business, by contrast, is performing well and overtook Europe as the group's second-biggest source of fee and trading income during the year. Profits from North America rose over five times from a low base, but are still about a third less than Europe due to the heavy marketing investment being undertaken. It's having some effect, though, with new dealing clients in North America in the second half of 2017 up 7% on the first half.

That supported a welcome rise in active clients (those that have transacted within 12 months) across the group of 3.7% to 156,700, after being becalmed at around 151,000 since September 2015. It was also good to see a sharp drop in the cost of acquiring new clients in Australia, with management noting a 45% fall in the ‘cost per registration' between April 2016 and 2017.

Forecast cost improvement

These improvements were swamped, though, by the fall in average transaction values and an 18% underlying increase in expenses. Just over half of this increase was due to wages, with an increase in IT employees to complete a technology upgrade, including the migration to Amazon Web Services, completed last October. Costs that don't immediately drive revenue are expected to stop rising in 2018 leading management to forecast that revenue growth will exceed cost growth.

That's behind management's guidance that – subject to markets – profit will increase in 2018, and market expectations for earnings per share of 9–10 cents, compared to the 8.0 cents just reported.

At the middle of that range, the stock is on a forward PER of about 16, which doesn't look expensive, particularly given that the earnings come through wholly as free cash flow.

Overall, the result should provide reassurance for those who didn't take our advice to sell back in February, and probably justifies the 20% rise since then.

However, having lost patience with the company we're not inclined to cut it much slack. Without firmer evidence that it can expand its client base and maintain margins, it's hard to pin down a price at which we'd buy the stock. We're therefore switching to AVOID.

* OzForex holds significant amounts of client cash while waiting to settle deals. As a result, interest forms an important part of its operating profit, so it uses ‘earnings before tax, depreciation and amortisation' as a reporting measure rather than the more common ‘earnings before interest, tax, depreciation and amortisation'.