Seek Hunting Market Dominance

This story features SEEK LIMITED. For more info SHARE ANALYSIS: SEK

Seek has disappointed those on the lookout for extra profits in FY19 as it ramps up expenditure to capture market share.

-Meaningful earnings growth considered unlikely in the near term
-Headwinds may not just be confined to Mexico and Brazil
-Significant shareholder value could be created over the next 3-5 years
 

By Eva Brocklehurst

Seek ((SEK)) is investing in growing market share, shelving profit growth expectations for another year and intensifying its bid to become the dominant player in China, SE Asia and Australia.

The company has pre-released FY18 financials and provided its first guidance for FY19. Revenue growth of 16-20% is expected, a reduction from the 24% experienced in FY18, while EBITDA (operating earnings) growth forecasts are reduced to 5-8% from 15% in FY18.

FY18 earnings were at the top end of guidance, as expected, but were eclipsed by the significant downgrade to FY19 versus expectations. Yet Macquarie finds the revenue outlook still positive and actually ahead of expectations, supported by a combination of Seek's execution on growth strategies and a robust macro backdrop.

The broker accepts that while the top line momentum is strong, the level of reinvestment is an offset, and the starting point for FY19 is for no earnings growth. Given the implied downgrades and the lack of clarity over when earnings leverage might reward shareholders, several brokers remain concerned over the valuation.

Citi advises investors not to expect meaningful earnings growth in the near term although, in the longer term, there is substantial potential. Nevertheless, this needs to be tempered by the risk of a cyclical downturn in one or more of the company's major markets.

The company has also written down $178m in the value of subsidiaries in Brazil and Mexico stemming from macroeconomic and political issues. CLSA does not believe the headwinds are confined to Mexico and Brazil and job ads are also considered likely to experience some weakness in Australia as a federal election looms. The Asian markets of Singapore and Malaysia remain weak as well.

Risks

Morgans observes the risks to the outlook in the near term include a softening of the Australian labour market, slow take-up of product by major recruiters, unfavourable moves in exchange rate as well as sharp downturns in either the Chinese, Southeast Asian or Latin American economies.

Yet, the company offers investors exposure to the global hiring cycle and the increased migration of employment advertising to online, and to date has shown the ability to respond to competitive threats. As the stock is trading in line with the target, Morgans upgrades to Hold from Reduce and considers the stock good value for long-term buyers at around $19 a share.

Reinvesting For Growth

The company is seeking to become the dominant player in China and thus, Morgans notes, most of the new incremental investment is being made through Zhaopin. Operational expenditure is increasing to $49m above trend in FY19, in pursuit of market dominance and more durable long-term growth. This has prompted a downgrade to the broker's forecasts to reflect the FY18 result and guidance for FY19.

Citi observes guidance now incorporates flat net profit in FY19 and this will mean, if delivered, that net profit has been flat for three years despite the strong cyclical tailwind from higher Australian employment and job advertisements.

CLSA is not completely against reinvesting for growth, but the extent suggests the company is becoming more defensive regarding its position, particularly in China. Returns on invested capital are expected to decline to 9% in FY19, not that flash for an internet business in the broker's view. CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, has a $19.57 target and Underperform rating.

Morgan Stanley is more positive, acknowledging the higher costs but noting revenue growth is well ahead of expectations. The broker points to accelerating growth in China/Zhaopin and Southeast Asia.

Morgan Stanley accepts the shares will trade weaker in response to the news, and the absence of a flow on from stronger revenue growth to higher operating earnings is disappointing. The broker's fundamental view is centred on the outlook for significant shareholder value to be created over the next 3-5 years.

The database has it all, two Buy ratings, three Hold and three Sell. The consensus target is $19.46, signalling -2.5% downside to the last share price. Targets range from $15.00 (Citi) to $23.00 (Morgan Stanley, Ord Minnett).

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