Class Continues To Wrap Up Strong Returns

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Financial services software provider Class Ltd delivered a strong FY17 although margin growth is expected to taper off as investment ramps up in FY18.

-Migration of AMP accounts to take some time, providing breathing space
-Positive superannuation reforms may take longer to realise
-SMSF administrative purchasing decisions may be pushed out
 

By Eva Brocklehurst

Financial services software provider Class Ltd ((CL1)) delivered a strong FY17 result. Established clients grew 7%, and contributed around 26% to the growth in the portfolio. Cost control and operating leverage delivered a better margin performance.

Operating earnings (EBITDA) margins expanded to 48.4%, versus 44.5% in FY16. Margin growth is expected to taper off as investment in the business ramps up in FY18 to drive customer acquisition.

Average pricing for SMSF (self managed super funds) fell -1.4%, driven by the volume discount for the Findex accounts coming online in the second half. Brokers observe some customers are growing accounts under administration and qualifying for volume discounts.

The migration of AMP ((AMP)) accounts is deferred, as AMP has to give the company 90-days notice before migration begins and it could take around six months for these accounts to move fully once notice is given. The company is set to lose around -7% of its SMSF volumes over time as a 11,000 AMP accounts are taken in-house.

Ord Minnett believes growth is attractive, as not many software companies actually grow organically, and the returns are high. Furthermore, market expansion is putting the company within reach of segments it previously did not address directly.

Wilsons agrees, expecting strong adoption of cloud administrative software will drive growth, while the fact that AMP contracts may stay around for longer is helpful in terms of near-term revenue.

Overall, the broker reduces forecasts for earnings per share in FY18 and FY19 by -7% and -12%, respectively, because of the re-basing of margins on the back of increased investment to drive long-term growth. Compound operating earnings growth of 21% is expected going forward.

Wilsons, not one of the eight stockbrokers monitored daily on the database, retains a Buy rating and $3.52 target. The broker believes the ongoing adoption of cloud-based SMSF functions and the fact that Class holds a dominant market share remain supportive factors for the stock.

Super Uncertainty

Ord Minnett observes the share price has moved sideways since January which is probably stemming from the fact that super reforms will take longer to materialise. Nevertheless, this is still a positive tailwind, and one which is likely to benefit the company as well as patient investors over the next 12-18 months.

The broker also believes the emerging organic growth warrants consideration and non-SMSF product still offers significant upside potential. Ord Minnett expects more than 30% per annum growth rates in free cash flow through FY18-20 and the associated visibility of this growth profile justifies a premium rating. The broker reiterates a Buy recommendation and $3.80 target.

Moelis, not one of the eight monitored daily on the database, maintains a Hold rating and $3.37 target. The broker does not believe regulatory uncertainty will help in FY18, as requirements for real-time reporting have been pushed back by nine months to June 2018 from October 2017.

This means the need for accountants to adopt cloud-based real-time reporting products is likely to be deferred. Moreover, changes to capital gains tax relief is likely to be a distraction for accountants in FY18 and this mean SMSF administrative purchasing decisions could also be pushed into FY19.

The company's platform reduces the time spent on administration and compliance of SMSF and investment accounts, enabling accountants, financial planners and administrators to focus more on revenue-generating work.

FNArena's database has two Buy and one Hold for Class, with UBS and Morgans yet to update on the results. The consensus target is $3.52, suggesting 21.1% upside to the last share price.
 

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