Seek: Result 2018

If you trust Seek's management – and we most certainly do – there's really only one number you need to focus on. Okay, maybe two.

The first is revenue growth. Seek increased revenue by 25% in the 2018 year to almost $1.3bn, or a still-healthy 14% excluding acquisitions (mainly reflecting Seek moving from 50% to 80% ownership of Online Education Services).

The second useful number to focus on is cash flow. Seek's operating cash flow rose 40% to $393m in 2018 although, removing some one-off items, underlying growth was 8%. Seek's cash flow has quintupled over the past decade, and so have its dividends. This business is still growing at a decent clip.

You can safely ignore the bottom line – net profit – even though the market occasionally gets in a huff about the lack of movement down below. That means you can also ignore the ritzy price-earnings ratio of 39.

Seek's underlying net profit for the year was $200m, about the same as last year. The number flat-lined for the same reason it has for several years: management is reinvesting in product development, technology and marketing. We're confident these investments will produce profit growth down the track.

That's deep, man

They already have in ANZ, Seek's most mature business. ANZ revenue grew 71% between 2014 and 2018 and, while the strong job market has helped, so has past investment. In 2018, ANZ generated growth in revenue and earnings before interest, tax, depreciation and amortisation (EBITDA) of 16% and 18% respectively as hirers took up more ‘depth' (premium) products. The quality of the growth was better too because Seek isn't increasing prices quite as much as it used to.

Seek's remaining businesses are at a much earlier stage of development. As a result, Seek Asia reported flat EBITDA in 2018, although revenue growth accelerated to 11% in the second half. As it did in ANZ, Seek Asia's profit growth should arrive after a lag.

Chinese business Zhaopin, now delisted from Nasdaq following the takeover by Seek and its private equity partners, is also reinvesting to widen its moat. While Zhaopin's 2018 revenue grew 21% in spite of the move to a ‘freemium' business model, EBITDA grew just 3%. With competitors choosing to lift prices, Zhaopin is instead redoubling its efforts on taking market share.

The main blight on the result was the Latin American operations. EBITDA fell 24% in Brazil and 28% in Mexico, with challenging economic conditions and competitor activity taking a toll. Unfortunately there also seem to be operational issues, including with the once-promising Mexican education business.

We hope this isn't a case of far-flung operations falling apart now that Seek has taken full ownership. As neither Brazilian nor Mexican earnings are expected to recover in the short term, Seek wrote down its Latin American operations by $180m in 2018.

Seek's remaining significant education business, Online Education Services, grew revenues by 10%. But with the Western Sydney University partnership still ramping up, EBITDA was flat. Significant opportunities remain to partner with other universities or expand the range of courses offered.

Bad drag

Seek's ‘early stage ventures' continue to be a drag on profitability – to the tune of $29m in 2018 – as they will be for a while yet. But we expect the company to pick some big winners eventually; while technically not one of Seek's early stage ventures, Zhaopin's holding in MaiMai, the Chinese equivalent of LinkedIn, is rapidly increasing in value.

Seek announced its outlook for 2019 earlier this month and, because the company will keep reinvesting this year, net profit will once again be flat. Revenue growth will, however, accelerate to between 16% and 20%, with strong results expected from ANZ, Asia and Zhaopin.

Much as we might like it to, profit growth doesn't always arrive each and every year. Sometimes it arrives in a rush, and we suspect that will happen with Seek. If current reinvestment doesn't improve operating metrics – or if Seek's ANZ division experiences a cyclical downturn – management should be able to cut costs. Current earnings remain well below Seek's potential.

Pending a comprehensive review, we're keeping our Buy price at $16 given the risk that a cyclical downturn could hit the ANZ division at some point. We are however raising our Sell price to $27 to reflect the high potential from Seek Asia, Zhaopin and Online Education Services. Seek is one of Australia's highest-quality businesses and it remains firmly a HOLD.

Note: The Intelligent Investor Equity Growth and Equity Income portfolios own shares in Seek. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in Seek.