OzForex: Interim result 2015

An investment in OzForex is not for the faint-hearted. After starting off with a 28% jump on listing in October last year, it has since risen or fallen by 3% or more on 32 trading days – or roughly once a fortnight on average.

Four of those occasions have come in the past week: it looked ominous for the interim results when the stock fell 3% and then 5% on Wednesday and Thursday last week, but it made 3% back the next day and rose 9% after the result was duly announced yesterday.

This volatility should come as no surprise. The shares are highly priced because much growth is expected, and they're therefore sensitive to small changes in these assumptions. What's more, these assumptions are themselves highly volatile, due to OzForex's relatively unprotected position in the rapidly growing but highly competitive international payments market.

If you want to sleep soundly, heed our High business and share price risk warnings and keep below a portfolio weighting of 3%. If you do that, though, then the interim results suggest an investment in OzForex could pay dividends (fat, chunky, fully franked ones).

We initially upgraded the stock in OzForex upgraded to Buy on 7 Aug 14 (Buy – $2.28) after falls of 19% on 27 May and 8% on 6 Aug, after the company reported disappointing full-year and first-quarter results respectively.

What upset the market so much was that, after a 34% jump in new dealing clients in the first half of the 2014 financial year (the six months to September 2013), they actually fell slightly in the second half, and were on course to do the same in the first half of 2015 after a weak first quarter.

New clients rise

The good news is that didn't happen. New dealing clients in the second quarter actually jumped 11% to 15,200 to put the first-half total at 29,000, 4% ahead of the prior year. Now that might not sound like much for a high-growth stock with a fancy price, but it's important to recognise that new clients come in fits and starts and are tied closely to foreign exchange volatility, most notably between the Aussie and US dollars. The exchange of these currencies accounts for nearly a quarter of OxForex's transaction value – three times the second-placed pair ($A/£) – and volatility between them makes people think about signing up.

In the six months to September 2013, the Aussie dollar sank from 105 US cents to 90 before recovering slightly to 94. In the most recent half, the $A was stuck between 93 and 94 almost the entire time, before tumbling below 90 in September.

The implication of all this is that new clients saw the appropriate pick-up in September. Management confirmed this in the conference call – although it referred somewhat tamely to a 'spike' in September and then suggested that a major cause was the Scottish referendum.

A healthy 69% of clients who had transacted in the year to September 2013 transacted again during the year, compared to a prospectus forecast of 65%. This is an important number as it's a lot cheaper to retain a client than it is to find a new one.

Transactions lag

Overall, the number of clients active in the past 12 months rose 21% to 130,000, which is no mean achievement given the strong comparison period. The number of transactions lagged slightly, growing 18% to 336,000, and the average value slipped 3% to $22,300. The latter is a little disappointing as it's supposed to grow when the Aussie dollar falls since clients should need more of them to buy the overseas money they need. However, the fall in the A$'s average value from 95 US cents in the prior half to 93 in the latest one was relatively minor.

Total transaction turnover rose 14% to $7.5bn, on which OzForex made a margin of 0.55%, up from 0.53% in the prior half, to give a 19% increase in net operating income to $41.6m.

With a large chunk of costs relatively fixed, operating margins rose from 38% to 41%, resulting in operating profit jumping 28% to $17.2m. (Note that OzForex includes interest in its operating profit, since it forms a genuine part of its operating income.)

However, a rise in the tax rate from 26% to 29% meant that net profit rose 'only' 25% to $12.0m. That gives a total of $22.4m for the 12 months to September (on a pro forma basis), compared to the prospectus forecast of $22.1m.

US profitable

One exciting piece of news from the result is that the US business became profitable for the first time. It can't have been much because, combined with the Canadian operations, the operating profit was only $0.6m but, with North America growing operating income by 40% in the half, it's fair to assume there will be more to come. And as with the rest of the business, it should come at increasing margins.

It also shouldn't absorb any further capital, since OzForex actually spins off more cash as it grows – rather than absorbing it – because it sits on client money for a short time before paying it out.

For the group, free cash flow came to $14.8m in the half – a remarkable and unsustainable 123% of net profit. We'd settle for 100% or even 90%, though we can't imagine where they'd spend the money. Acquisitions excepting, we'd expect the company's 70–80% payout ratio to eventually increase.

So while OzForex may operate with little protection in a competitive market, that market is growing quickly and it's very lucrative. The stock is up 10% since we upgraded, putting it on a multiple of about 25 times the 10 cents of earnings expected for the current year. It's also almost bang on our Buy price. For the moment, we'll leave the recommendation, but given the risks we'll be looking to downgrade to Hold if it gets much higher. BUY.