Small Caps | Feb 27 2019
Revenue growth prospects are strong for fund management platform Hub24 but brokers remain concerned about an escalation in costs.
-Revenue margins likely to be pressured by price competition for funds
-Escalation in costs could lead to questions about scalability
-Business still expected to benefit from flows to specialist platforms
By Eva Brocklehurst
Substantial growth in costs featured in the first half but Hub24 ((HUB)) has moved to reassure the market that there is still leverage in the business and cost growth will slow. Additional expenses were incurred in governance, distribution, infrastructure and services. An FY21 target for funds under administration (FUA) of $19-23bn was reiterated.
One of the positives in the result was revenue margins, which were maintained in spite of a minimal contribution from a large client transition. Citi expects revenue margins will still decline, and forecasts a margin of 49 basis points by FY21. This will be driven by sharper pricing for larger deals, more clients with higher balances, an increase in price competition and lower cash balances on the platform.
Revenue growth prospects are still shaping up well and Credit Suisse estimates a 10% rebound in equity markets in the first quarter of 2019 has benefited the company's FUA by around 6%. The March quarter is typically the weakest of the year for flows and, therefore, this is considered a good sign.
In contrast, Macquarie suspects FY20 consensus estimates for operating earnings (EBITDA) are unlikely to be achieved because of higher operating expenses and capitalisation.
While the broker assesses the sell-off in the stock may be seen as creating an attractive entry point, the step-change in cost growth and lack of visibility make this difficult to pin down. Shareholders are now investors in a company that is re-sizing its operating costs post the Hayne Royal Commission.
Wilsons also takes a negative view, downgrading to Sell, with a target of $10.43. The broker was most surprised by the substantial lift in employee-related costs, reflecting senior and middle management recruitment.
The broker asserts it would always support a business investing in growth but Hub24 is not priced for disappointment. Wilsons, not one of the eight monitored daily on the FNArena database, expects the company will gain significant market share in the medium term, as the drivers of funds from incumbents to specialist platforms are firmly in place.
Citi believes the escalation in costs could lead investors to question the scalability of the company's platform. The broker expects platform margins will increase over the medium term, and forecasts three-year compound growth in earnings per share of 65%, as the business benefits from a structural shift towards specialist providers. Nevertheless, downside risk is also envisaged for industry pricing over the medium term.
Credit Suisse agrees the cost outcome was disappointing but is confident the company is now set up to deliver in coming years. Importantly, revenue was robust and beat in terms of margin, and that should reduce some concerns about pricing.
The broker accepts there will be debate around the level of cost growth and to what extent operating earnings margins are sustainable. Using competitor Netwealth ((NWL)) as guide, Credit Suisse believes the platform division of Hub24 is likely to migrate towards a cost base of around $50m by FY21, which should support margin expansion in operating earnings to at least 45% on its platform.
FUA is currently around 20% above the first-half average, which the broker believes will set the business up for firm growth in the second half. Significant flows are expected in coming years amid higher growth in earnings per share. As the stock is fairly priced, Credit Suisse maintains a Neutral rating.
Macquarie suspects the allocation of transition costs as a one-off cost in the report implies there are no large deals on the horizon. Therefore, net fund flows may return to normalised growth rates in the near term. Credit Suisse argues the company is well-placed for additional transition deals, given the quality of its offering and the desire for independent advisers to move towards specialist platforms.
The company added 10 licensees in the second quarter, providing access for an additional 137 advisers, and completed the transition of around $700m of Fitzpatricks Wealth in December. Credit Suisse notes some suspicions that pricing was low for this deal and this will erode revenue margins. However, the broker calculates the effect is likely to only be -1-2 basis points.
FNArena's database shows one Buy rating (Ord Minnett, yet to comment on the half-year), two Hold and one Sell (Macquarie). The consensus target is $12.70, suggesting 8.2% upside to the last share price. This compares with $13.07 ahead of the report. Targets range from $9.90 (Macquarie) to $14.21 (Ord Minnett).
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