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Treasure Chest: More Pain For Computershare?

Treasure Chest | Jul 09 2019

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Morgan Stanley is convinced that earnings risks are building for Computershare and the de-rating of the stock is not over.

-Mounting risks in FY20 from UK mortgage servicing
-UK specialist lenders budgeting for lower origination volumes
-Are lower yields priced in?

 

By Eva Brocklehurst

Is Computershare ((CPU)) vulnerable to further shocks? The stock is down -20% from peak levels and now trades at a discount to the ASX200 for the first time since 2016. Morgan Stanley is convinced earnings risks are building and the de-rating is not over.

After a three-year upgrade cycle, consensus estimates have now begun to fall and Morgan Stanley expects broadly flat earnings in FY20. Risk is skewed to the downside, stemming from interest rate cuts, corporate actions and possible investment in new growth strategies.

Ord Minnett expects guidance in FY19 will be achieved but agrees the main issue is FY20 and beyond. UBS suggests that while there are near-term headwinds in the UK, there is a stronger story for the company in the US and, in the company's favour, Credit Suisse notes the balance sheet is strong and some capital can be deployed to accelerate growth.

At its investor briefing in May management acknowledged risks in FY20, and possibly beyond, from UK mortgage servicing yet expects more cost savings will help grow the issuer services business.

However, the futures market is pricing in rate cuts and US banks have already begun lowering rates paid for term deposits. Morgan Stanley estimates every -50 basis points cut to the Fed Funds rate drives -5% downgrades to the company's earnings per share. There are also structural risks from US shareholder attrition, escheatment (transfer to the state) of abandoned property and faster payments.

The company is targeting an unpaid principal balance (value of loans under service) in US mortgage servicing of US$150bn with an emphasis on capital-light growth. As of April 30, this was US$101.7bn. Computershare has scale and is seeking growth in adjacent markets, including US registered agents and corporate services. Ord Minnett considers this a good long-term option, albeit unlikely to affect earnings in the near term.

Yet global registry revenue margins are also under pressure and Morgan Stanley notes the company has lost clients to Broadridge, Wells Fargo, Link Administration ((LNK)) and Equiniti.

UK Implications

To offset the earnings hole that will become an increasing drag on trading multiples as investors look at FY21, Morgan Stanley assesses the company needs to lift origination volumes by 2-5 times current levels within 1-3 years.

Having recently met with UK specialist lenders the broker asserts this will not happen. Brexit is constraining the supply of capital and many lenders are budgeting for lower origination volumes. Private equity is reluctant to supply further capital to the sector until Brexit is resolved.

This is not to say that the market is not healthy, as the lenders have observed that demand for mortgages is fine. That said, tax-deductible buy-to-let mortgage interest will be phased out by 2020 and potentially limit demand. All up, the broker envisages a disconnect between trading multiples and fundamental concerns, maintaining an Underweight rating for Computershare.

Management has also noted it is seeking additional cost offsets in mortgage servicing and there are stranded costs left over for another year totalling US$35m, after the merging of the UK Asset Resolution business encountered delays. Weaker property volumes have also resulted in soft organic growth.

Macquarie suspects the market was too optimistic about the organic growth profile of UK mortgage servicing. In May, the broker raised its rating to Neutral from Underperform, following the response in the share price to the company's investor briefing and as overly-optimistic consensus expectations were lowered.

Macquarie incorporates broadly stable yields going forward, expecting later on there will be some yield benefits as around $3bn of hedged balances roll off and are redeployed at higher rates. Yet Morgan Stanley disputes that lower yields are now priced in and the recent downgrade was oversold. The broker believes the FY20 outlook commentary will be the driver of the stock at the results on August 14.

FNArena's database shows seven Hold ratings and one Sell (Morgan Stanley). The consensus target is $16.97, signalling 1.1% upside to the last share price. Targets range from $13.50 (Morgan Stanley) to $18.10 (Credit Suisse, Deutsche Bank).

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