This company is set to deliver 55% earnings growth in FY23

Computershare's FY22 key results

• Management revenues up 12.2% to US$2.6 billion
• Return on invested capital up 130bps to 12.2%
• Management NPAT up 23.5% to US$350.3 million at constant currency 
• Management EBIT up 19% to US$530.9 million at constant currency
• Net debt of US$1.18 billion net 
• Capital expenditure (CAPEX) of US$42.8 million
• End-of-year dividend of 30 cents per share (AUD), up 30% (unfranked)
• Management earnings per share of 58.03 cents (US), up 10.6%

Note: This interview took place on Wednesday 10th August 2022. This stock is a top 10 holding in Credit Suisse's Australian Equities portfolio, as well as its multi-asset funds. 

What were the key takeaways from this result? What surprised you the most?

The result was ahead of consensus expectations and the management has guided to a stronger than expected 55% earnings increase in the next year. So that's positive earnings momentum. 

The key area of upside compared to expectations really was that earnings were leveraged to rising short-term interest rates. So margin income is rising earlier to a higher level than expected over the upcoming year. 

The acquisition of the Wells Fargo Corporate Trust is proving to be well timed and beneficial because of the benefits of both interest rate leverage and they're making good progress on synergy extraction. And the balance sheet strength and the 30% rise in dividends were also positives. 

On the downside though, the core business performance was weaker than expected. They're experiencing higher cost inflation and weaker activity, and that's flowing through to their operational performance in FY23. 

So, overall, the key takeaways were that earnings momentum and performance were positive, but earnings quality is lower than anticipated.

What was the market’s reaction to this result? Was this an overreaction, an underreaction or appropriate?

The market is reacting to the lower quality of the operational result. And there are headwinds there with the core business that have impacted the outlook. 

I think it is also worth bearing in mind that the stock has performed pretty strongly this year. So you can see profit taking into results where there is some question mark over quality, even though momentum is positive. 

The other thing to bear in mind is that the market is, in a macro sense, digesting the potential direction of monetary policy. And that will obviously impact the sustainability of their margin income. 

Investors already expect that monetary policy has peaked and there may even be easing next year. So that could affect investor perceptions of Computershare. 

At this point, analysts have reacted positively overall, but they have reservations over its core business momentum. The overall reaction from consensus earnings will be that Computershare will be upgraded given the guidance. So, I think today's movements look like a profit-taking reaction.

Would you buy, hold or sell Computershare on the back of these results?

Rating: HOLD

The results confirm that the company is experiencing very positive earnings momentum - they're extracting that earnings optionality to the rising rate cycle. Strategically, they're executing very well. And there have been good returns across their portfolio. 

However, given it has performed so well this year, we would expect it to consolidate as markets assess the direction of monetary policy. That said, the valuation looks okay, the multiple is not demanding, but there is a much larger income component which is much more volatile. 

We believe the group can overcome the headwinds in the core business and we would expect the stock to perform well, but it could face a period of consolidation following its strong performance this year. 

What’s your outlook on Computershare and its sector over FY23?

Outlook on Computershare

Overall, our outlook on Computershare is positive. The macro factors remain constructive. 

We are expecting a peak in interest rate rises and therefore margin income to occur, but that will be at a much higher level than what has been the case in the past. So much of that income gain will be sustainable. 

The inflation issues that they're experiencing should also subside as economic growth slows. So some of these macro positives and negatives will even out to remain broadly positive for the group. 

And operationally, the company's actually executing quite well and there are efficiency opportunities that they'll continue to focus on and grow their market share. They are also well positioned from a balance sheet sense, and the acquisition they made has paid off pretty well.

Outlook on diversified financials 

For financials that have had depressed income from investment returns, we think the outlook for them remains reasonably positive. Whereas financials that are reliant on cheap finance are going to face more challenges going forward. So the picture for the sector is mixed. 

Activity won't be as buoyant as it's been. But companies with capital that's been earning very little will see sustainable improvements in earnings from that capital. Whereas users of that capital, like Macquarie (ASX: MQG), will face more headwinds going forward. 

Are there any risks to this company and its sector that investors should be aware of given the current market environment?

The main risk is the potential volatility and reliance on margin income. It's become relatively large in the FY23 outlook. And there is a risk, therefore, that proves to be unsustainable if monetary policy is eased aggressively. 

It is also the case that they are reliant on financial market activity and there could be a macro risk around that as well - and at the same time as easing. So there are reasons why, from a cyclical point of view, there could be downward pressure on earnings as we look further out into late FY23 to FY24 if those factors turn inverse. 

There is another risk to be conscious of. Obviously, the Wells Fargo Corporate Trust acquisition was a very good move, but there have been some diversification moves that have not worked as well, such as the expansion of mortgage services, which has underperformed expectations.  So if the company feels pressure to grow, there's a risk of losing some of that discipline. 

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?

Well, we're positive on the market. I'd probably say it's around 2 right now. From a high-level asset allocation perspective, we do see value in large parts of the market. We're comfortable with resources, we're reasonably comfortable with many of the financials. 

Though, there are significant pockets outside of those sectors that are still pretty expensive, for example, tech and consumer discretionaries. So we think it's important to be exposed to the areas that dominate the market capitalization. I think that's where the value is.

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