Treasure Chest | Jul 22 2021
This story features COMPUTERSHARE LIMITED. For more info SHARE ANALYSIS: CPU
FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Computershare is highly leveraged to the interest rate cycle so is it time to start factoring in higher rates?
-Credit Suisse opts to be an “early mover” on the cash rate cycle
-Computershare offers growth from other areas such as corporate actions
-Yet, is it right to price the stock based on a longer-dated view?
By Eva Brocklehurst
How can investors price Computershare ((CPU)) based on current multiples and in view of the eventual rise in cash rates from very low levels? The share price has rallied recently, attributed to views that inflation could be about to materialise.
Computershare has strong leverage to higher interest rates and the recent acquisition of the Wells Fargo Corporate Trust Services (CTS) has doubled exposure to margin balances to more than US$35bn.
Credit Suisse believes there is scope for earnings, hence the share price, to double in the next 3-5 years and makes its case by pointing out out the potential for higher margin income stemming from increases to cash rates of around 100 basis points, implied by the current forward interest curve.
The broker acknowledges picking the timing of the interest-rate cycle is difficult so incorporates a large margin of safety, while still preferring to be an early mover rather than risk missing the opportunity.
Growth is expected to return in FY22, despite headwinds to margin income, given the benefits of cost reductions, and Credit Suisse also notes there are other areas of growth such as corporate actions and share plans.
Macquarie forecasts FY22 earnings (EBIT) growth, ex margin income, of 13% supported by cost reductions, a recovery in share plan revenue and elevated bankruptcy in class action volumes. This should be partially offset by normalising corporate actions.
The broker highlights foreclosure restrictions in the US have been extended. These restrictions impact mortgage servicing through the loss of foreclosure-related ancillary revenue and pushing the mix towards performing loans which are lower margin. Still, Macquarie retains the view that long-term growth prospects exist and remains encouraged by the steepening of forward curves.
Credit Suisse expects cost reductions and synergies should provide substantial benefits including the rest of the Equatex synergies. The CTS acquisition, due to close during the first half of FY22, should provide around 24% benefit to earnings per share.
Citi is more negative – the short-term outlook is tough. The broker accepts the leverage to short-dated interest rates is significant yet, outside the CTS acquisition, expects margin income will drop in FY22 and any recovery in US mortgage servicing will be modest.
Hence, the question is whether the focus should be on earnings pressure over the short term or the inflation hedge provided by the medium-term leverage to rising short rates. Citi acknowledges the issue is likely to play out for some time but, in conclusion, asserts FY22 guidance could disappoint.
Even if predicted rate increases are valid, the broker ponders the dilemma surrounding which year of earnings the market will use as a base to price the stock and concludes it would be unusual for the market to price the stock on long-dated earnings. As a result, Citi considers the current metrics make Computershare appear expensive.
Higher Rates Ahead
Yet Credit Suisse believes, while higher interest rates are a major part of its investment view, even without this scenario there is a case for around 10% growth in earnings per share per annum.
The business has provided valuable protection against inflation within portfolios, the broker notes, with around US$20bn of balances exposed to interest rates, while every 25 basis points increase in interest rates adds 10% to earnings.
If inflation materialises, interest rates will rise and so will the company's earnings. Moreover, some of the business, particularly share registry, uses inflation-linked price clauses in contracts which should protect the stock from the impact of inflation on the cost base.
Credit Suisse flags the fact interest-rate markets are pricing in significant increases to the cash rate by FY26, averaging around 100 basis points across the US, Canada and UK.
The broker calculates, post the acquisition of CTS, Computershare has US$80bn of which 25% is exposed to interest rates. Of the exposed balances a subset of 70-75% is exposed to US interest rates, 15-20% to UK rates and 5-10% to Canadian rates.
These balances are largely leveraged to the cash rate. Of note, partially offsetting this, will be the FY22 re-basing of margin income and higher interest costs on debt.
Long-Term Versus Short-Term View
In setting its target, raised to $23.20 from $13.90, Credit Suisse emphasises it applies a 20x multiple to what is an FY26 scenario as this multiple represents the current market price/earnings ratio. In addition, valuation is also revamped to reflect the US$950m of capital that could be available to Computershare shareholders during that period, to either fund M&A or undertake buybacks.
As a result the broker upgrades to Outperform from Neutral. Morgans has taken a shorter-term view and, in an overview of all diversified financials, recently downgraded to Hold from Add as the stock has rallied 20-25% since March.
Morgans also makes more conservative operating earnings margin assumptions, while acknowledging there are both risks to the downside and upside. On the downside there is unforeseen deterioration in the core registry business amid a loss of market share and an inability to further grow in new verticals such as mortgage servicing.
On the other hand, the upside risk centres on an improving macro environment affecting global bond yields as well as corporate actions.
FNArena's database reflects this mix of views with three Buy ratings, three Hold and one Sell (Citi). The consensus target is $17.90, suggesting 14.8% upside to the last share price. Targets range from $14.60 (Ord Minnett) to $23.20 (Credit Suisse).
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