Computershare looks oversold on near-term 'macro' headwinds
While no one was expecting Computershare Ltd's (ASX: CPU) full year result to be particularly good, greater disclosure on the magnitude of the near-term headwinds confronting it – which led to a 38.9% fall in statutory profit to $153.6 million – goes a long way to explaining why the world's biggest share registry is trading at a sizable (33%) discount to its intrinsic value. The share price tanked around 20% since the horror full year result early August, and while at face value this does signal an attractive entry point, the share price is likely to come under more near-term weakness.
Chart 01. Computershare Ltd's price drops after releasing full year results
Source: Rivkin, Saxo Bank
What's becoming painfully clear this reporting season is investor and analyst inability to accurately build bad news into price and Computershare is no exception. The share price is likely to feel the further brunt of multiple macroeconomic setbacks, especially from the US which accounts for just under half (around 43%) of total revenues.
Interestingly, analysts are struggling to gauge the fuller impact of the currency hit on stocks with significant international earnings exposure. While consensus estimates were expecting growth in full year 2016 at 3%, Computershare's CEO Stuart Irving is forecasting a subdued outlook for 2016 – leading to a 7.5% weakness in underlying earnings.
In addition to lack of earnings growth within the core business, Computershare's offshore earnings are also exposed to the AUD and CAD exchange rates which have fallen against the USD – impacting margin income, margins in the core shareholders services business and rising costs. Interest rates that have remained at record lows for longer than anyone anticipated also means the yield Computershare generates from corporate activity – which has incidentally held up well – is correspondingly low.
While Computershare's home market only accounts for 10% of revenue, its market share can expect to come under more intense pressure from Link Group which plans to list after the reporting season. But in response to new competition, Computershare has been upskilling its sales force to help retain existing customers and gains new ones.
The recent decision by Computershare founder Chris Morris to buy 67,000 shares at an average price of $9.90 suggests the stock has been oversold by a market that's overreacted to the current macroeconomic issues confronting it. While return on equity (ROE) has averaged 23.94% since 2006, it recently fell to 14.04%, however this is expected to jump to 27.03% and 24.67% in 2016 and 2017 respectively.
Similarly, while earnings per share (EPS) has been very poor over the last five years, it is forecast to grow from $0.36 in 2015 to $0.79, $0.83 and $0.85 in 2016, 2017 and 2018 respectively. The current share price does appear to represent a fair entry point to capitalise of future upside from higher interest rates and mergers and acquisition activity, plus ongoing cost-cutting measures.
Following the acquisition of the largest third party mortgage manager in Britain, HML, Computershare is actively seeking more growth opportunities in this sector. It also wants to partner with the many small banks in the US to offer "warehousing" services for loan origination.
Without question, much of Computershare's future upside will come from management's proven ability to successfully acquire and integrate new businesses. However, with net-debt to equity of 112%, plus a long-term funding gap of $35 million, watch closely how future acquisitions will be funded, its impact on balance sheet, and the potential impact on shareholder value.