Weekly Reports | Jul 13 2018
Weekly Broker Wrap: franchising; regional banks; software; Rhipe; debt purchasing; and FE Investments, Scottish Pacific & CML Group.
-Inquiry into franchising could extend consumer law protections and increase ACCC powers
-Deficiencies in regional banking sets it up for consolidation
-Ord Minnett considers software sector increasingly important for small cap investors
-Is the debt purchasing sector ripe for consolidation?
By Eva Brocklehurst
Credit Suisse highlights the developments taking place with regard reform of the franchising industry as a result of the final hearing of the parliamentary committee inquiry. The broker concludes that the scale of evidence began to impact the committee's thinking as the inquiry unfolded and it is now looking at addressing structural imbalances.
Of interest to the broker were the number of items taken on notice including: the number of stores earning less than $60,000 in operating earnings; the proportion of the 799 store total where shift trimming had occurred; and the number of stores that were bought back to resolve disputes.
In the broker's view policy is likely to address the imbalances in contractual arrangements through extending Australian consumer law protections, increasing ACCC powers and codifying good faith provisions under the franchise code.
These reforms would imply major structural headwinds for Australian franchising and, in combination with increased labour costs, raise significant questions regarding the profitability of franchisees. In turn, this may lessen the attraction of the industry for new franchise investors.Regional Banks
Citi believes declining retail banking returns and consumer preferences have exposed the deficiencies in the regional bank business models. This has created an urgency to act. In other markets, similar banks have turned to consolidation to solve deficiencies or, in some cases, private equity sponsors.
The broker believes it is time for a similar type of consolidation to occur in Australia. Regional banks appear to have an over-reliance on branch-based banking, be underweight broker distribution and lack omnichannel presence, with insufficient size to adequately invest in digital.
The main consolidation prospect, in the broker's opinion, is a Bank of Queensland ((BOQ)) and SunCorp ((SUN)) bank merger. The broker observes the bleak retail banking headwinds continue for both Bendigo and Adelaide ((BEN)) and Bank of Queensland, with these stocks down -3% and -17% in the year to date respectively.
Software represents around $15bn of market capitalisation and 7% of this Small Industrials index and Ord Minnett notes the sector is performing strongly. The broker makes a detailed comparison of the sector leaders, believing software is increasingly relevant for small cap investors.
The broker has initiated coverage of Technology One ((TME)) with a Buy rating and $5.45 target, believing the company offers both attractive growth and improving earnings quality.
Altium ((ALU)) has a Sell rating and $16.54 target, as Ord Minnett cannot reconcile the current valuation with the level of recurring revenue. The broker believes the stock is heavily exposed to up-front licence sales and its recurring revenue is the lowest amongst peers.
Ord Minnett also initiates coverage on WiseTech Global ((WTC)), with a Hold rating and $14.96 target, believing it offers investors leverage to a global software story in its early stages. Following a substantial re-rating over recent months Ord Minnett plays the long game and intends to wait for a more attractive entry point.
Finally, Ord Minnett considers IRESS ((IRE)) offers investors a relatively low risk exposure to software while promising double-digit growth and higher recurring revenue. A Hold rating and $11.24 target are in place.
Rhipe Ltd ((RHP)) provides cloud-based subscription software service licences to a growing number of IT providers across the Asia-Pacific region. The company also provides consulting, marketing and support to its network.
Bell Potter considers the cloud services market a growing opportunity and the company is well-positioned to gain exposure to the structural trend. Moreover, management appears able to build out its presence and maintain strong earnings momentum. Bell Potter initiates coverage with a Buy rating and $1.25 target.
In reviewing the debt purchasing sector Canaccord Genuity questions whether the industry is ripe for consolidation. And will comprehensive credit reporting even the playing field? Amid conflicting industry rhetoric the broker suggests access to capital is the key determinant of returns.
In this regard Credit Corp ((CCP)), Pioneer Credit ((PNC)) and Collection House ((CLH)) are all considered to have plenty of funds going into FY19. Credit Corp has an opportunity to plough capital into the US market and Pioneer Credit has commenced personal loan origination in its own right.
Heading into reporting season, the broker suggests Credit Corp is typically the most explicit about return hurdles and this makes it most likely to pull back on domestic purchasing if pricing does prove to be stretched. Meanwhile, Pioneer Credit has a most momentum in the near term in its cash collections. The broker maintains a Buy rating on these two.
Canaccord Genuity has a Hold rating on Collection House, choosing to maintain a neutral stance ahead of the results while acknowledging the shares have fallen -13% since the end of May.
FE Investments ((FEI)) provides SME lending and micro-financing. The company has created a successful franchise in New Zealand which it aims to replicate in Australia over the next 12 months. PAC Partners initiates coverage on the stock with a Buy rating and target of $0.18.
Loan growth and net interest margin expansion are expected to drive strong upside to earnings. The company has a large addressable market in Australian SME lending, estimated to be a $20bn opportunity. PAC Partners believes the company can leverage technology to significantly scale its lending activities.
Scottish Pacific ((SCO)) has reported strong growth in invoice turnover and reaffirmed guidance regularly throughout FY18. Canaccord Genuity suggests it may have erred conservatively in order to restore market confidence following a surprise downgrade in its maiden year of listing.
The broker believes high single-digit earnings growth is comfortably achievable. Favourable economic conditions are driving strong turnover growth across the client base and the UK should deliver an improved contribution. The broker considers the stock cheap relative to the outlook and maintains a Buy rating and $3.42 target.
CML Group ((CGR)) has upgraded FY18 operating earnings (EBITDA) to $17m from $15.5m, and reaffirmed FY19 guidance for $19.5m. Canaccord Genuity expects this will ultimately prove to be conservative versus its forecasts.
Guidance may not fully capture the contribution from the Thorn Group ((TGA)) debtor finance book let alone any additional organic growth. Canaccord Genuity has a Buy rating and $0.70 target.
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