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UK OK, But GBST Hits Downgrade Button

Australia | Feb 02 2017

Weak conditions in the UK caused financial technology provider GBST to hit the downgrade button. Scrambling to adjust forecasts, brokers still consider the long-term outlook is secure.

-Revenue shortfall expected to be temporary and work pipeline solid
-Wealth management in the UK positive in the longer term
-Yet, concerns linger about the implied decline in the second half


By Eva Brocklehurst

Another weaker-than-expected outlook for FY17 has been offered, this time by financial technology provider GBST ((GBT)). The downgrade is attributed to four project deferrals in the UK, where weak operating conditions prevail, and a cancellation. The company has indicated it will not adjust its cost base in response, as it expects the revenue shortfall to be temporary, and the pipeline of work remains solid.

Given the company's inherent fixed cost leverage, compounded by its current elevated expenditure on R&D, the lack of services work has had a material impact on second-half profitability. Despite this, Deutsche Bank retains a Buy rating on valuation and expects momentum will improve materially in FY18. The stock is at five-year lows, despite solid revenue and client growth.

The company expects FY17 operating earnings (EBITDA) of $12m, materially below broker forecasts, with consensus previously around $19m. A minor positive, Deutsche Bank notes, is that the international capital markets division is expected to report an EBITDA profit in the first half, and this is a division that has been highly challenged over the past seven years.

Deutsche Bank makes material downgrades to FY18 expectations to reflect the trading update but still expects reasonable growth, driven by an improvement in services revenue. The broker remains attracted to the strong cash generating and capital-light business model.

Excessively Weak Guidance In Context of CoFunds Acquisition

RBC Capital Markets is cautious about the outlook given the company suggested the second half looks worse than the first half. The broker believes the guidance is particularly weak in the context of Aegon acquiring CoFunds. This was a significant deal for the company, which closed on January 3 after much delay.

The broker believes this explains a lack of work in the first half but significant work would have been expected some time in the second half. Guidance indicates this is not the case, as the segment will make a loss at the EBITDA level after R&D. RBC Capital Markets, not one of the eight stockbrokers monitored daily on the FNArena database, has downgraded to Underperform with a $3.00 target.

CLSA, also not one of the eight, downgrades to Outperform from Buy* with a $3.20 target. The broker notes the week guidance for the second half highlights a lack of leverage with clients and a reliance on lumpy services revenue, amplified by an uncertain macro environment in the UK.

The broker queries whether this is the first of more UK-related Brexit downgrades. Nevertheless, CLSA remains optimistic about GBST's long-term prospects and expects FY18/19 earnings to improve after completion of the Composer upgrade and the start of the CoFunds migration.

Problems Temporary?

Morgans also considers the problems temporary, driven entirely by unforeseen contract deferrals which hit at the same time as the company's peak IT development expenditure occurred, with the upgrading of Composer and the new Catalyst retail advisor product. In the short term, the broker notes there is no solution to the IT development cost issue as backbone system upgrades cannot be deferred.

IT costs are expected to remain high until the second half of FY18. The broker expects wealth management customer services revenue will build slowly, as customers can only defer system maintenance for so long before they hurt their own performance. The company is building a powerful global franchise as a supplier of core wealth management platforms and Morgans expects substantial long-term earnings growth. The broker retains an Add rating.

Earnings growth in Australian capital markets over the next five years looks challenging to UBS and structural headwinds remain a feature of the broker's base case for the segment. While conditions are subdued and additional investment and currency volatility will weigh on divisional earnings, the broker believes the longer term picture for UK wealth management is positive. The division continues to benefit from regulatory reforms which are driving a lift in advisor/D2C platforms.

Still, UBS is concerned about the extent of the implied second-half earnings decline in the UK. Continued weakness in the British pound is likely to have an impact on the company via offshore earnings translated back into Australian dollars and the potential for further project deferrals. UBS downgrades to Neutral from Buy, given the headwinds and uncertainty.

FNArena's database shows two Buy ratings and one Hold (UBS). The consensus target is $3.85, suggesting 23.9% upside to the last share price. This compares with $4.69 ahead of the update. Targets range from $3.40 (UBS) to $4.40 (Deutsche Bank).

* CLSA has a five level ratings system in which Buy is the top rating and Outperform a step below.

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