Iress Susceptible To De-Rating

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Citing a delay in the timing of client decisions, Iress has downgraded 2017 guidance. Brokers are somewhat underwhelmed by the outlook.

-Downgrade not driven by a single project or region
-Susceptible to de-rating, hence needs to deliver on 2018 growth forecasts
-Returns from acquisitions failing to live up to expectations
 

By Eva Brocklehurst

Financial services business Iress ((IRE)) has downgraded guidance, acknowledging two recently-acquired businesses are performing below expectations. The company, citing a delay in the timing of client decisions and an increase in its cost base, has revised 2017 revenue guidance to $435-440m, which implies 12-13% growth and, at the mid point, suggests a -6% downgrade to consensus forecasts.

Iress has indicated the downgrade is not driven by one project or one region, although cited delays in South Africa and lower consulting revenue in Australia.

The company has signalled Financial Synergy & INET are performing below expectations. This is consistent with Deutsche Bank's concerns that Financial Synergy retains a much higher level of project revenues that the company's core business, exposing Iress to higher earnings volatility.

CLSA believes the underwhelming first half result obscured a solid top line in key markets, and remains confident the company can further penetrate the UK market and continue top-line growth in 2018, delivering both margin expansion and earnings growth. CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, has a Buy rating and $14.20 target.

The delays raise some questions for Credit Suisse. The company has consistently indicated that results can be affected by timing and this is particularly the case in the UK, which is growing off a smaller market share base than in Australia.

Hence the broker believes it is prudent to wait and see as, following a weak first half, there is less second half growth than previously hoped. The broker gives the company the benefit of the doubt, expecting growth rates will improve in 2018.

Ord Minnett notes cost growth ran ahead of revenue in the first half, as management indicated some of this was required for the execution of key projects. This was expected to reverse in the second half as revenue came online and cost normalised.

Macquarie calculates revenue guidance would be $10-15m lower if the impact of foreign exchange is included. The main impact in terms of FX is from an adverse movement in the AUD:GBP. Recent changes to segment disclosures make it more difficult for the broker to estimate the impact on segment profit, which the company has indicated would be between $123-128m, implying just 2% growth.

Downside Risks

The broker considers the stock susceptible to a de-rating, as it has missed consensus expectations on two consecutive occasions and recent acquisitions appear to be delivering below expectations. Macquarie asserts, in order for the company to maintain its premium rating relative to the market, it will need to deliver on earnings and revenue growth in 2018.

Although management signalled the majority of the weakness is attributable to timing, Deutsche Bank believes weak underlying momentum, combined with an increased reliance on (lower quality) acquisitions, increases the downside risks. The stock is a high quality business but this is reflected in current pricing, in the broker's opinion.

Over the past seven years the company has deployed more than $600m on acquisitions and Ord Minnett suggests the returns from the businesses are failing to live up to expectations.

Assuming only a flat contribution from existing business since 2010, the broker estimates capital deployed appears to be generating a pre-tax return of only 6%. The broker maintains a Lighten rating, awaiting signs of a sustained recovery in profitability.

FNArena's database shows three Hold ratings and one Sell (Ord Minnett). The consensus target is $11.20, suggesting 2.3% upside to the last share price. This compares with $12.49 ahead of the update.

This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.
 

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