OFX warns again and sacks CEO

OFX Group chairman Steve Sargent joined the board six months ago and only became chairman in November, so he's probably a good person to allocate the blame for the company's latest profit warning – and he wasn't pulling his punches.

‘We feel good about the things … we're working on,' he explained in yesterday's conference call, ‘but the execution against that was often coming up short'.

Ouch. Apparently the board decided around the half-year result in November (about the time that Sargent took over) that chief executive Richard Kimber would need to be replaced if OFX had another bad quarter, and so it has.

Kimber will leave the company just 19 months after joining. He will be replaced by John ‘Skander' Malcolm, who has 23 years' experience in the financial services industry in Australia, NZ, the US and the UK, most recently as CEO of Australia and New Zealand for GE Capital (where he worked alongside Sargent).

Aspirational goal

Kimber's plan to double revenues by 2019 (to $200m) has also gone by the wayside, now being described by Sargent as an ‘aspirational goal', which ‘will not materialise within the timeframe previously outlined'.

Looking shorter term, the statutory net profit for the year to March 2017 is now expected to be ‘at least $19m', compared to the prior guidance of slightly more than last year's $21.8m. That in turn means the company is expecting the second half to deliver something similar to the (disappointing) first-half net profit of $9.7m, instead of the $12m previously anticipated. The new profit figure is taken after an undisclosed cost of sacking Kimber, but it's still a big downgrade.

The performance hasn't been helped by the dislocation following the Brexit referendum back in June. Not only has the British pound fallen by 20% against the Australian dollar, but there have also been fewer large value transactions originating from the UK. All told, the average revenue on such transactions fell by about 35% in the December quarter. As a result, fee and commission income will now be $3m less than anticipated for the year to March.

The company denied that competition had exacerbated the impact, but it's hard to have much faith in that given the track record of missing targets.

New client problem

The UK weakness looks like it accounted for most of the downgrade, but the company also revealed that it had signed fewer new clients than expected in Australia during the third quarter. On the call, chief financial officer Mark Ledsham explained that this was because the company's investment in programmatic display advertising was taking time to implement effectively.

Programmatic display advertising automates the buying of online display ads to specifically target a company's most likely leads. It's an iterative ‘test and learn' process and Ledsham suggested it was beginning to show results, just more slowly than expected.

But if that's the case, then it seems a bit premature to sack Kimber. Perhaps the implementation has been found wanting; or perhaps Sargent just wanted his man in the job.

Or perhaps competition is taking a toll despite Ledsham's assertion that it didn't ‘pose a significant issue'. Barriers to entry (in terms of gaining licences and banking relationships), he said, were keeping new entrants at bay, while the size of the market meant that existing players were working to grow the market and take business from the banks as opposed to from each other.

Maybe he's right, but in that case, how come the company has found it so difficult to sign new clients, ever since it first disappointed on this metric in May 2014, just seven months after floating.

Active clients (who have transacted in the past 12 months) stood at 152,000 in September 2016, compared to 151,000 a year earlier and 130,000 in September 2014 (below the prospectus forecast for 140,000).

As a result, the expected earnings per share for the year to March 2017 of about 8 cents will be less than the underlying 8.6 cents recorded in 2014. That's not great for a supposed growth stock that first traded with a prospective price-earnings ratio of about 30.

Investment case broken

Like Sargent, we also want to be clear about where we lay the blame for this recommendation – entirely with ourselves. We put too much faith in the underlying financial dynamics of the business – most particularly its cash generation.

But strong cash generation on its own does not make a great business. For that you need competitive advantages and, while OFX has carved out a niche undercutting the big banks on international payments, it's looking increasingly hard for it to maintain and grow that niche.

With the stock now on a prospective price-earnings ratio of around 16, we're calling it quits. UK transaction values could recover and the Australian marketing could start to sing, in which case selling now will compound our original mistake. The network of licences and is also of some value and could attract another takeover offer. But this is not the quality growth stock we once thought and we're not going to hang on in hope. Our investment case is broken and we're heading for the exits.

We're reintroducing our price guide with a Buy price of 80 cents and a Sell price of $1.20. SELL.

* 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'.

Note: This article was originally published showing an incorrect price of $1.27, which was the previous day's close. In fact the price at the time of publication, shortly after the market opened on 2 February 2017, was $1.31.

Note: The Intelligent Investor Growth and Equity Income portfolios own shares in OFX but, depending on price movements, expects to Sell them. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.