Small Caps | Feb 14 2018
GBST Holdings generated strong cash flow in the first half and has gained some new contracts, amid early signs its business is stabilising.
-Weak first half affected by large strategic R&D expenses
-Well capitalised and able to fund development costs from cash flow
-Technological upgrade should help win new work
By Eva Brocklehurst
GBST Holdings ((GBT)), which provides technology services to the financial services industry, has had its challenges over recent years but brokers find signs of stabilisation and an improving outlook.
The company has affirmed guidance for FY18 operating earnings (EBITDA) of between $20-25m, before strategic R&D costs that are estimated to range between $10-15m. Brokers envisage the medium term risks involve this additional investment in R&D, or any glitches in technology as infrastructure is upgraded.
There is also still uncertainty regarding IT outsourcing decisions in the UK. Moreover, the company is exposed to currency volatility with the GBP. That said, GBST is generating cash, has no debt, and is expected to benefit from an improving outlook in the UK wealth management segment. Margins should increase as recurring licence fees contribute a greater portion of earnings.
The company reported a weak, albeit well flagged, first half, affected by large strategic R&D expenses as the IT infrastructure is upgraded across the wealth management and capital markets divisions. A new client is now on its Composer platform and two more are in transition. The first tranche of the account migrations from Cofunds has also been made.
The result is the first of many that is required to turn the company around but the margin of safety is reasonably high, in Deutsche Bank's opinion. The broker has greater confidence that the business has stabilised.
Australian wealth management and capital markets both declined materially because of previously-announced customer losses, down -22% and -17% respectively.
Yet, Deutsche Bank observes the quality of the earnings was good and, internationally, wealth management generated 19% growth in revenue, aided by the Cofunds migration work that will continue into the second half.
While R&D investment is elevated, CLSA agrees there were a number of small positives in the first half result including strong cash flow, new clients and performing projects. Services revenue slipped in the first half but this was affected by project delays and the broker expects it to rebound.
UBS remodels its profile on R&D, lifting outer-year forecasts substantially, although suggests a recovery is already priced into the stock. Strategic R&D is set to increase significantly over the next few months.
The company has migrated Deutsche Bank from its share system which could encourage other stock market participants to upgrade, although UBS suspects ASX regulatory changes for SWIFT messaging may be a greater catalyst.
Morgans believes the company is developing a global franchise as a supplier of core systems to large banks in wealth managers. While recent setbacks have clouded the outlook and the stock may remain weak in the near term, the broker considers the company well capitalised and able to fund development costs from cash flow.
UK Wealth
UBS notes the UK wealth management industry is benefiting from strong structural growth following reforms, while a consolidation of the platform market is ongoing.
The broker expects the company's UK wealth management earnings margins to lift to around 10% by FY21, following the upgrade of its front end. There is substantial upside risk if the upgrades are well executed, in the broker's opinion.
CLSA, too, was encouraged by the outlook for UK wealth management, understanding some contract announcements will be forthcomng shortly and help appease investors regarding the medium-term outlook.
The company has announced distribution deals in Japan and the US for its Syn platform and, while unlikely to generate material revenue from these contracts until FY20, brokers believe this has potential. Furthermore, the presence of the platform in Asia continues to expand and the business is highly scalable across the region.
CLSA, not one of the eight stockbrokers monitored on the FNArena database, suspects the market does not fully understand the mechanics of the company's technological upgrade, or how it will positively affect the ability to win new work. This perception may take time to shift.
The broker considers the current earnings trough an opportunity to buy the stock and retains a Buy rating and $3.10 target.
FNArena's database shows two Buy ratings and one Hold (UBS). The consensus target is $3.02, suggesting 34.1% upside to the last share price. This compares with $2.69 ahead of the results.
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