Are Tyro Payments Shares In The Buy-Zone?

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New broker research suggests the time may be right to buy shares in Tyro Payments, after a general decline in technology shares and a negative market reaction to recent first half results.

-First half results for Tyro Payments recently disappointed
-Nonetheless, brokers have maintained Buy ratings
-Scalability and operating leverage are generally expected
-Recent trading updates show a rebound in transaction value

By Mark Woodruff

As for many technology-focused stocks, the share price for payment processor Tyro Payments ((TYR)) has been trending downwards since November 2021.

Unfortunately, first half results in late February only accelerated the trend.

Results disappointed due to increased operating expenses and a lack of operating leverage, according to UBS. Disruption from lockdowns in NSW and Victoria impacted earnings by around -$4-5m, while the company also delayed pushing through price increases.

Nonetheless, the broker suggests investors are currently presented with an attractive entry point for shares, as the business is on the verge of margin expansion and positive free cashflow.

UBS initiates coverage with a Buy rating and a 12-month target price of $2.30 and is not alone in being upbeat. The FNArena database now has five covering broker ratings (including UBS), all with Buy ratings and a consensus target price of $2.97, which suggests 76.5% upside to the last share price.

The company’s core payments offering revolves around providing purpose-built payments solutions for small and medium sized businesses primarily in the Retail, Hospitality and Health sectors.

The Australian merchant-acquiring market is dominated by the big four banks (around 74% of terminals in FY21), with Tyro Payments being the fifth largest merchant-acquiring bank by number of terminals.

UBS’ investment thesis rests upon the company achieving scalability and operating leverage, which takes time. As a result, investor focus should be upon medium-term valuation multiples.

On this basis, the analyst estimates Tyro Payments is trading at a -25% discount to its peer group of comparable payments/technology stocks.

Scalability and operating leverage

Many global payments peers demonstrate scalability, with a median earnings (EBITDA) margin of around 40%. Hence UBS expects Tyro Payments to substantially increase margins over the medium term. At the same time, it’s acknowledged 40% margins won’t be attained, as the company has smaller scale as an A&NZ-only player, and a higher level of merchant churn.

The broker anticipates Payments sector margins in A&NZ will moderate over time due to competition and a change in business mix. Under these circumstances, it’s considered vital the company’s merchant loan product gains traction for the longer-term benefit of larger, stickier merchants.

The analyst estimates that 5% growth per year in merchant loan originations through to FY26 will add around 50bpts to the projected 11.7% margin for that financial year.

Overall, UBS forecasts operating leverage over administration and other fixed cost lines will drive margins higher and estimates a 16% margin in FY30.

Following first half results, Morgans also expects leverage to emerge over time and noted the company could support growth with $150m of cash and financial investments as at 31 December, 2021.

However, Macquarie is more sceptical, and suggested the result raised questions around the ability to generate operating leverage in the competitive payments industry, given limited pricing power and elevated demand for technology staff.

Despite holding this view, the broker upgraded its rating to Outperform from Neutral, believing the negative share price reaction to the result was overdone.

Tailwinds for market share

Tyro Payments holds a 4.4% share of the $670bn total card payments market in Australia and UBS estimates the company can reach a 7.7% share by FY26.

The company is set to benefit from growth in its ecommerce offering and penetration into new verticals, explains the broker. Moreover, the new Go Reader offering should assist, along with further partnerships and a general trend toward cards from cash.

Looking forward

Following first half results, Morgans believed any solid margin improvement will have to wait until FY23. It was felt support for merchants on pricing will likely continue until at least the fourth quarter of FY22, and expenses associated with the 2021 Medipass Solutions acquisition (May 2021) will remain a second half drag on earnings.

Nonetheless, a trading update in the first week of March showed a February rebound in transaction value from a typically weak January, noted to Ord Minnett. 

The monthly transaction value was $2.8bn, an increase of 43% year on year. Since then, another weekly update (as at March 11) also showed a 33% increase.

The broker expects transaction value will continue to gain on the back of improving retail and hospitality conditions as concerns over the omicron variant subside.

Wilsons, not one of the seven brokers updated daily in the FNArena database, is conscious that any positive share price momentum may be difficult should the company face ASX200 removal in June’s ASX rebalance.  

The broker maintained its Overweight rating after first half results though lowered its target price to $1.91 from $3.03, after assessing the impact upon sentiment of wage inflation, increased investment spend and the delay to earnings growth.

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