We review the fundamentals and technicals for IRESS (ASX:IRE) in order to assess whether the re-rating in the share price since the release of full-year results earlier in the year is sustainable.
The Company is a supplier of technology solutions for clients in the financial markets, wealth management, and mortgage sectors. Operations are in Australia, NZ, UK, Asia, Canada and South Africa.
For the retail stockbroking and private wealth management industries, IRESS has a unique selling proposition. It offers a complete service that meets a significantly large portion of a client’s core system needs on a simple platform. Most the Company’s licence fees comes from wealth management (mostly financial planning) firms. This is where revenues are only marginally moved by changes in equity market conditions.
IRE provides the XPLAN financial services software system for the financial planning and wealth management industries in ANZ, the UK, South Africa and Canada.
UK Wealth Management Remains the Main Profit Growth Driver
As has been the case over the last 2-3 full year periods, the Company’s earnings growth in FY18 (the Company has a 31 December balance date) was driven by stronger parts of the business. With Australian Wealth Management and UK offsetting ongoing weakness in other areas of the business. In particular, APAC Financial Markets (where revenue growth is flat and margin is declining) and UK Sourcing (which is presently lower growth relative to the rest of the UK business).
We consider that there appears to be no new earnings growth drivers. Having said that, consensus estimates remain slightly above the guidance range provided by the Company (+3-8% Segment Profit growth). The contributing factors to this being:
1. Growth in the Australian Wealth Management and UK businesses are expected to remain at similar levels into FY19, following strong demand and client wins. Recent Company commentary indicated that: i) Australia Wealth Management (~30% of group revenue and profit) is performing well, with growth continuing into 2H19 and expected to continue into FY19 at the same rate (+9%), and ii) The UK Wealth Management (~30% of group revenue and profit) continues to benefit from client wins and improving demand for outsourced software solutions.
2. Following an elevated level of investment in recent years, which has seen operating costs growth exceeding revenue growth, operating leverage returned in 2H19. This was as both operating costs and non-operating costs declined and IRE’s revenue benefitted from investments undertaken in prior period (such as client project implementations). Accordingly, while there is potential for further margin improvement in FY19 – as improved scale in the UK supports the prospect of further operating leverage – margin expansion may be hampered by the fact that non-operating costs, as a result of a recent acquisition, is expected to be more in line with CY18. In addition, revenue and cost growth remain subject to the timing of client projects and ongoing changes in industry conditions.
Gearing Level Remains Conservative
The balance sheet remains conservatively geared. This is despite the gearing level (on a net debt to Segment Profit basis) increasing to 1.5x, from 1.3x as at 31 December 2018. This was the result of an acquisition in late May. Further, debt serviceability is high. Cash conversion (94% in FY18) is typically strong given the capital-light nature of the business. Also because a high portion (~90%) of recurring revenue from license fees.
We consider IRESS to be fully valued. This is because it is currently trading broadly in line with its historical 1-year forward P/E multiple of ~25x. It also has a lower EPS growth profile (5-year mid-single digit EPS growth) than some ASX-listed technology peers.
Considering the absence of any new earnings growth drivers and the upcoming interim results due on 23 August, we maintain our cautious view on IRE at present.
Over the medium-term, corporate activity remains a potential catalyst. This is given that the Company is a small player on the global stage. Most of its competitors are significantly larger in terms of revenues, earnings and market capitalisation.
Our comments in The Dynamic Investor on 23 July indicated that IRE was in a 5th wave on the way back down and that it would likely fall to under the June low. We were also expecting some support back in near $12.50. So far it appears to be following the script with IRE falling after our report and then finding support around $12.50. This means that the stock is at the right levels to stage a rally. This is if their results on 23 August are good enough. It is risky to be jumping in now, but it is worth keeping on the watchlist here. If we get a good result, then IRE has a good chance of rallying to new highs for the year.
Michael Gable is managing director of Fairmont Equities.
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