Computershare Limited (CPU) Earnings Call Transcript & Summary

Welcome, everybody, to the Computershare 2020 Half Year Results Presentation. [Operator Instructions] I'll now hand over to our first speaker, CEO and President, Mr. Stuart Irving.

Good morning, everyone, and welcome to Computershare's 2020 Half Year Results Conference Call. Thank you for joining us today. Nick Oldfield, our new Chief Financial Officer, is with me, along with Michael Brown, from our Investor Relations team. On this call, I will take you through the key aspects of our results and provide an update on how we see the rest of the year given we are affirming guidance today. As usual, there's a new presentation pack released to the ASX. We've also added this presentation to the Investor Relations section of our website, computershare.com. In these results, we have started the new business stream reporting. Group totals are unaffected. The new business stream reporting aligns our financials with our global business structures as we've talked about. It's the way we manage the business. And to help you with your analysis, we have included updated versions of the previous financial slides. Now this is arguably the longest results deck Computershare has ever released, so good luck to you all with that. And with that in mind, I won't bother you with a page turn though. I'll focus my remarks on Pages 2 and 3 of the presentation. Nick will then take you through the slides on our financial results. Then, after some concluding remarks, we will open up the call for your questions. Now also, as a reminder, we'll be talking about U.S. dollars and in constant currency terms unless we state otherwise. Okay. Let's start. There are really 2 key elements I want to focus on today: one, unwrapping the half; and two, bridging the full year guidance. As you can see on Page 2, the result for the first half of FY '20 was resilient at an operating level, although earnings were down. At a headline level, management revenue was up 1.2% and management EBITDA was up 2.2%, reflecting consistent operating performance. Lower interest rates and balances and higher tax rate impacted earnings, and management EPS was down 16.7% in the first half. We knew going into the half that UKAR delayed cost savings would impact our U.K. profits, and we anticipated U.S. interest rate cuts. What we did not anticipate was U.S. rate cuts occurring early in the year and the implications of the new U.S. Base Erosion and Anti-Abuse Tax. Now we had guided to approximately a 27% tax rate for the full year in August, and we got that wrong. It does go towards explaining the divergence between EBITDA and EPS. So how do I look at the numbers? Well, to me, it's the management numbers that exclude the impact of margin income revenues, excludes the IFRS 16 noise and strips out Karvy. That's the true like-for-like operating performance of the business as it is today. And it also reflects what we can control because our focus is on controlling the controllables. Now on that clean basis, management revenue is actually up by 4.6%. EBITDA is almost exactly flat at $197.7 million, and the EBITDA margin fell slightly to 19.3%, down 90 basis points. I'll now move to Page 3 to unwrap the positive and negative factors that are driving our performance. It really is a result of 2 parts. Our strategies continue to focus on strengthening our businesses' competitive positions, building scale in our growth engines and driving efficiency gains across the group to deliver margin expansion, free cash flow and improved returns. Our largest growth engine, Issuer Services, has a positive growth outlook. US Register Maintenance outperformed industry trends in the half, delivering another period of operating revenue growth and margin expansion. We have invested in upgrading our capabilities and front-office initiatives and continue to focus on product and service improvements. Encouragingly, the recent new headline client wins in this business recognize the strength of our value proposition. The recent Corporate Creations acquisition accelerates our Issuer Services strategy in the U.S. And we know Corporate Creations well, having worked closely with them for the last 3 years, and the acquisition extends our scale and capability in the complementary, large and growing registered agent market. But every entity that wants to do business in a U.S. state needs to be properly registered and the filings need to be accurately maintained. This generates high levels of recurring revenue. We're also excited about this strategic move because it enables us to package registered agent services to our wider range of existing registry clients both in the U.S. and internationally. Now we did flag that we expected Corporate Actions revenues to be weak, and they were in the half. They fell by 17%. These higher-margin, event-based transactions were impacted by lower activity levels across most markets. Perhaps macro uncertainty affected corporate confidence. Similarly, Stakeholder Relationship Management revenues fell by 49%. The Employee Share Plans, another one of our growth engines, performed strongly. It's a good news story. Revenues and EBITDA increased by 24%, and excluding margin income, EBITDA was up by a more impressive 39%. We enjoyed strong organic growth and a full 6 months' contribution from Equatex compared to 7 weeks benefit in the pcp. Equatex continues to outperform, and over 250 clients have now been upgraded to the market-leading EquatePlus platform with the staged rollout to follow across Asia, North America and Australia. US Mortgage Services, our third growth engine, also clearly performed well. We delivered record revenues, up 43% and took advantage of buoyant market conditions to make disciplined investments to build scale and higher returns. Now I will call out the capital employed in the business. We spent $130 million (sic) [ $139 million ] on net MSR purchases in the half to increase UPB by almost 10% to close to $112 billion. Total capital employed temporarily increased to $647 million. Lowering interest rates caused significant market activity and with that, originations, and we took advantage of the market conditions to acquire MSR product. Whilst the capital is above our long-term average spend of between $60 million to $80 million, in the second half, we expect to close a number of strip sales which will release capital. And going forward, we do expect that the next stage of growth to be less capital intensive. Finally, I'll mention UK Mortgage Services. As we announced at Investor Day, profits were impacted by the fall in the fixed revenue fee and the delayed migration of the remaining UKAR loans to our platform. Now I can confirm the migration of these assets will be completed by May. Even with this reduced result in the U.K., EBITDA for the combined Mortgage Services business increased to $76 million, a rise of 27.5%. And importantly, margins increased by 210 basis points to 22.7%. Putting that all together then, I would say, at the operating level, the revenue and profit growth in our key businesses have indeed offset the reduced contributions from our higher-margin, event-based businesses. The high-quality industrial with recurring revenues businesses performed well, but in this half, the optionality that we talk about did not convert. Outside of the operating level, we did have some challenges. I'll start with tax. As I said before, it goes towards explaining the divergence between EBITDA and EPS. In the guidance assumptions we released in August, we said that we expected the tax rate for the full year to increase to around 27%. The rate in the first half was much higher than we expected at 31.6%. Now this is a complex issue, but simply put, we got the tax assumption wrong, and frustratingly, it's had a negative impact on EPS for the half. This was the first time the 1H results were also subject to U.S. BEAT, the new Base Erosion and Anti-Abuse Tax rules, and Nick will go into this in more detail later. And we've done a lot of work on this, and we now expect the tax rate for the full year to be between 29% and 31%. And we, like almost everyone else, have adopted IFRS 16, the new accounting standard for leases. IFRS 16 added close to $24 million to EBITDA in the half and increased depreciation and interest by the same amount. It's a net wash, but it doesn't inflate our management EBITDA results, and it's not significant at EPS, though. And you can find more details of its impact in the appendix. I'd also like to call out some other highlights of the results. Recurring revenues increased by 2.6% and now account for 78.3% of the total. Now that's the high-quality core industrial Computershare that we talk about. With our cost-out programs on track and making a good contribution, headline EBITDA margins increased to the top end of the consistent 10-year range at 29.7% and well above the 27.3% average for this long period. But of course, that was helped by IFRS 16. Computershare's capital position also remains an ongoing positive. We are able to self-fund our growth and capital management strategies and retain a strong balance sheet. Free cash flow increased by over 69% to $207 million in the first half. Including the cost for Corporate Creations, the acquisition we announced last week, the group's net debt-to-EBITDA leverage ratio is within the target range of 1.75 to 2.25x. In the share buyback program during the period, we have acquired over 2 million shares at an average price of AUD 15.85 per share. Now many of you will have heard me say before at Computershare, we focus on laying down and executing long-term growth plans, and I can see that our growth engines are performing to plan. So now importantly, let's move on to unpacking guidance. I know what you're thinking. Why are we keeping earnings guidance unchanged? How can we deliver management EPS down 5% for the full year when we're down 17% in the first half? Well, let me explain. Yes, guidance is unchanged at this point. We continue to expect management EPS for the full year to be down around 5%. To help you understand this, we spell out the anticipated tailwinds and headwinds in the second half that support our position, and you can see these factors on the bottom half of Page 3. This is a new page in the deck for us, certainly, given the right question that you're asking. In the second half, we expect to deliver positive management EPS growth on the pcp. That's implied in the numbers. However, it's not a huge step to get there. We need to deliver EPS growth on pcp of around $0.01 to $0.02. This growth should continue to come from our high-quality businesses. We expect a growing organic contribution from U.S. Issuer Services with a small accretive contribution from Corporate Creations in Q4. We expect continued momentum in Employee Share Plans. Clearly, positive equity markets are supporting high transaction revenues, but the recurring issuer paid fees are growing nicely, too. In US Mortgage Services, we should get a revenue and profit contribution from the UPB we added during the first half as well as additional growth. And as I said, we do expect to release some capital through strip sales. Now when we do this, we are selling part of the future revenue stream, so while I expect consistent growth in this business, don't bake in the first half's record growth into the second half. We are disciplined here, and we will continue to build this business carefully and to plan. And my nemesis, the tax rate, is expected to be lower than in the first half, although again, it is higher than we initially forecast for the year. The net result is that we expect these tailwinds to offset the headwinds and deliver positive earnings growth in 2H. But at Computershare, we're always balanced and realistic, and there are headwinds, no doubt. Margin income will be lower than in the first half. There's the full (sic) [ full half ] impact of the cuts in Q1, and we expect rates to trend lower in the second half as well. We're not -- we're also not expecting any significant recovery in Corporate Actions. We have not at this stage included any additional negative impact from the coronavirus, but we continue to watch developments very closely. That's an external X factor for all of us. We do, though, have good line of sight on a better 2H in Stakeholder Relationship Management given the project work we can see in the pipeline, and the 2H result should be better there. So overall, the momentum in Issuer Services, Employee Share Plans and US Mortgage Services should exceed the impact of lower interest rates and continued weak event-based activity. Beyond the results, for any 1 half year though, we remain committed to executing our long-term growth strategies. We are building the quality industrial businesses with growing recurring revenues and delivering efficiency gains across Computershare. Sometimes the optionality converts, although today, it hasn't. And we do look forward to delivering improved results and earnings growth for the second half of the year. I'll now hand over to Nick to go through the financials in more detail.

Thank you, Stuart. I will begin on Slide 11 and take you through our financial results. Starting with group revenue. You can see that revenue increased by 1.2% on the prior corresponding period. EBITDA is up 2.2% to $338.7 million. However, as you've heard, IFRS 16 has created a bit of noise here, and there's more detail around this on Slide 26. As a result, EBIT, which is down 8.3%, $267.1 million, is a better measure of comparative operating performance. Essentially, this reduction is made up of $8.1 million in margin income and approximately $17.5 million in UK Mortgage Services, being the first half impact of the delayed platform migration. Amortization expense increased $11.6 million to $32.8 million with $29.7 million of this total attributable to the increased investments in U.S. mortgage servicing rights. Interest expense was $3.8 million higher at $36.3 million, and $3.6 million of this increase related to IFRS 16. Finally, our income tax expense was higher at $73 million versus $65.8 million, whilst our effective tax rate for the half was also up on the prior year at 31.6%. Two things that happened here: First, we made lower profits in the U.K., a relatively lower tax jurisdiction for us, due to the reduced UKAR fixed fee and the delayed migration; and second, MSR valuations have fallen. These temporary differences have the effect of increasing our U.S. tax expense as a result of the new U.S. Base Erosion and Anti-Abuse Tax. And as a result of all these, management EPS was down 16.7% to $0.291 per share. So let's move on to Page 12. This is our revenue bridge, and I will just highlight 2 key points: One, Mortgage Services growth is shown after the $20 million in UKAR fixed fee drop-off, so a net increase of $60 million; and two, Business Services revenues fell $15 million, but net of the Karvy disposal, they increased $1.9 million. Slide 13 shows margin income compared to the last 10 half years. And the story here is a little nuanced. Margin income is 7% lower, but balances are actually 20% lower, meaning our average yield in first half '20 is better than it was in the first half '19. The story changes a little relative to the second half of '19. Margin income is again lower, but balances are actually 4% higher. And this lower average yield reflects the rate cuts in the first half. There's more detail around our balances on Slide 56. The next slide shows EBITDA margins by business stream. As you've heard, headline EBITDA is up 2.2%, but this includes an IFRS 16 benefit of $23.9 million. There's 2 points to highlight here. First, the IFRS 16 benefit is shown within the corporate and technology line in the table. This represents the rental expense paid by our businesses to corporate. This charge is then offset in depreciation and interest. And second, adjusting for Karvy, Business Services EBITDA just fell 1.7% over the prior corresponding period. Slide 15 breaks out EBITDA from margin income by business stream. And here, I would point out that the margin income decline wasn't uniform, growing in both Mortgage Services and Business Services by $6.5 million and $2.3 million, respectively, due to higher exposed balances in those businesses. Excluding margin income and normalizing for Karvy and IFRS 16, EBITDA is flat at $197.7 million versus $197.6 million in the prior period. This resilient performance highlights the strength of Computershare. On Slide 16, we detail operating expense, which, on a normalized basis, is 2.5% higher than the prior period. I'll make 2 comments here. One, the majority of the personnel cost increase related to acquisitions. However, there was a little bit of underlying wage inflation. And two, the direct cost increase of around $9 million included a number of one-off items that we would not expect to repeat. Slide 17 completes the picture on cost. We now show $30 million in Equatex synergies and $50 million from the UK Mortgage Services cost-out program on this slide. We expect to deliver $21.7 million of this, together with another $24.8 million as part of our stage 1 to 3 cost-out programs in financial year '20. Please note, the mortgage servicing savings do not consider the IT costs of the platform migration, and the total gross savings are not distributed evenly over the financial year. Our cash flow slide is Slide 18, and I'll just highlight some timing factors. Firstly, net receipts and payments increased by $44.1 million. This reflects UKAR fixed fee collections and some seasonality in our Continental European AGM business. Similarly, our income tax payments fell largely due to a prepayment made in the first half of '19. Our SLS advance funding requirements were somewhat higher than in FY '19, and this was in part new boardings and in part seasonality. We expect this to reduce in the second half. The MSR investment is split out between maintenance and growth, the $29.7 million on maintenance to offset amortization and an additional $109.6 million to grow the book. Again, we do not anticipate this level of investment continuing as we complete excess strip sales in the second half and our capital lite strategy takes shape in FY '21. I'll close my -- I'll close with some comments on the balance sheet slide on Slide 19. Net debt is some $98.7 million higher than at the end of June. This is after funding $139.3 million in MSR purchases, a share back (sic) [ buyback ] of AUD 32.9 million as well as an increased dividend of AUD 124.9 million. As a result of all of this, our net debt-to-EBITDA ratio increased to 1.97x. Adjusting for IFRS 16, the net debt-to-EBITDA ratio would have been 2.04x. I'll now hand back to Stuart for some closing remarks.

Thank you, Nick. Now let's finish on Slide 20 of the deck. As I said at the start, it's a resilient result of 2 parts. While our quality industrial businesses performed to plan, clearly, not everything went well. I can tell you we've worked very hard for a number of years now to build reliable, consistent growth at Computershare, and we focus on controlling the controllables. And we do expect to -- a return to first half, second half seasonality. And we've not seen that for a few reporting periods essentially due to large events in the first halves of the last 2 financial years. But we do expect positive earnings growth to resume in the second half. And as I stated earlier on, we need to deliver EPS growth of around $0.01 to $0.02 on the pcp to meet guidance. And we can see that in Issuer Services, Employee Share Plans and Mortgage Services growth. The high-quality industrial businesses with recurring revenues are performing. The long-term growth plans we're laying down to build scale and operating leverage in our key businesses are delivering positive results. And we expect that to drive earnings growth in the second half and beyond, and that's why we're leaving earnings guidance unchanged at this point. Now it's a long deck, and our "call it exactly as we see it" pragmatic approach shows our performance in every way, shape and form. And that honesty and credibility are key to us, and I hope you find all the disclosures useful. And we appreciate your interest and support. We're looking forward to seeing many of you on the road where we can talk about the major business lines in more detail and our plans for the future. Before we have these meetings, perhaps we'll now move on to questions.

[Operator Instructions] The first question comes from Simon Fitzgerald from Evans & Partners.

I just wanted to get a clarification of your second half EPS -- sorry, just for the second half of '19. Could you just clarify exactly what that was, so we're working off the right base in terms of the $0.015 plus for the second half '20?

Second half '20, Simon, was around $0.352 per share -- second half '19, Simon.

$0.356, did you say?

$0.352.

Great. Now also in terms of some of the moving parts essentially around the EBIT line, you talked about the bridge between the first half '19 to the first half '20. I'm interested in terms of the first half '20 to the second half '20 in terms of some of the bridge effects there. As an example, should we consider the full year depreciation and amortization as a reflection or double the first half '20? Is that what we're looking at?

The assumption around depreciation is a reasonable one, Simon. The amortization expense will increase in the second half to reflect the MSR investment in the first half, and those investments would fall uniform over the first half. And of course, there will -- whilst will be a little bit of an offset from strip sales, it will be subject to the timing of those strip sales, too. But I would expect amortization expense to be higher in the second half.

Okay. Yes, got that. And then just a final question. I appreciate there's been more or at least the cuts in U.S. interest rates to happen more quickly than what you forecast. The last cut was in October 2019, and at the AGM in November, it was sort of discussed that margin income would be modestly lower. Now we're looking at 8% to 10% lower. So is this really related to your now expectations of where you think interest rates are going to go for the second half of this year? Or maybe you could elaborate in terms of what's changed since November.

Yes. So look, there's 2 things that affect margin income revenues. One is the interest rates, and the second part is the balances. You can see, obviously, on the balances, if you go to the pcp, they're fairly well down because of some considerable stuff that we had in 1H '19 in Corporate Actions. So it's really just a reflection on the weaker Corporate Actions activity more than any assumptions on rates. So at the start of the year, we did expect 3 rate cuts in the U.S. Probably, as I said, happened a little bit faster than we had anticipated, 2 in the first quarter and then the last one in October. There is talk of perhaps the U.K. rate going down at some stage. But the assumption that's changed is it's really going to be around what balances may do, and Corporate Actions are an important part of that. So no major changes from the AGM on what the rate outlook would be but just that we think that there'll still be some softer Corporate Action balances throughout the rest of the year.

Your next question comes from Brendan Carrig from Macquarie.

So just the first question, it's just a bit of a point of clarification. So looking at the AASB 16 slide, it looks like there's about a $1.5 million impact at the NPAT line from the shift, which would imply sort of only about 0.5% impact to EPS. But at the full year, when guidance was provided, it was implied that there was going to be a sort of 2% to 3% negative impact for IFRS 16 in the guidance. Can you just maybe elaborate on what's changed in terms of that? Was it just working through it for 16 further got you to where you were?

Yes. Look, that's essentially right. There's a fair amount of moving parts on that. And back when we started out and doing our projections, we thought that it would be somewhere around about 2%, maybe 3%. And then as we've worked through that with our lease profile around the world, et cetera, it's just come in slightly lower for Computershare. So that's really the main difference.

Okay. And then just my second question. Obviously, guidance has been maintained, and you've spoken at length about it. It does appear that it's balance sheet led and that you've been able to deploy that capital into US Mortgage Services. Can you maybe just get a bit of a sense as to what amount of contribution the additional spend has provided in order for you to be able to maintain the guidance at the current level?

Look, I think the nature of our Mortgage Services business is that we do deploy capital on MSRs now whether that -- there's 2 elements of that. There's the maintenance stuff, which really keeps up with the book, that amorts, and then there's the stuff on top of that. We did go hard in the first half, not so much looking from a result perspective. It was more just to market conditions were very, very favorable. There was lots of origination activity, et cetera. I think going forward into the second half, we will probably end up with amort being fairly flat in terms of what we actually do, maybe just a little bit up in the second half. And I think I did say that don't expect the growth that you saw in the first half of capital deployed to be matched in the second half.

Your next question comes from Andrei Stadnik from Morgan Stanley.

Can you hear me okay?

Loud and clear.

Fantastic. So I wanted to ask, kind of looking into FY '20 and the run rate for EPS we should be thinking about, should we be thinking about the 2H '20 EPS as a starting point for FY '21? Or should we be thinking something more like a blended 1H and 2H '20 as a starting point for FY '21?

I don't know. I haven't done the calculations on what our FY '21 is. Yes. I have to sit down and go through that. I think that, normally, what you did see is, last year, our first half, second half were pretty much the same in terms of what that was. And in the second half, we expect to do $0.01 to $0.02 higher than the $0.352 that we did last year on pcp. Yes.

Got you. Got you. And then, look, my second question just around potential benefits from Brexit resolution in U.K., which obviously helps Continental Europe as well. I mean what are some of the potential tailwinds that can play obviously from that? And is it largely potentially high U.K. interest rates? Or are there more tailwinds that can play out?

Yes. Look, it's -- I think the Brexit benefits and cost to Computershare, we've sort of been tracking this for a while, I think the move for the U.K. out of Europe is a little bit of a cost headwind for Computershare as we head in for the rest of this year as we head -- basically restructure certain trading operations and regulatory operations to repaper some of our European clients out of the U.K. given that it's very likely that the passporting will disappear. So that's what's always been the sort of the downside on the Brexit. On the other upside and downside, it's really the macro factors that are really outside Computershare's control. It's unclear about what is going to happen on interest rates. There's different schools of thoughts about what the U.K. are going to be doing. An important one for us is probably going to be the housing market. The housing market has been a bit of a challenge. I think many people in the U.K. have been sort of putting off majors of either refi or housing moves decisions depending on what was happening with Brexit. Now that there's some clarity there, there's potential sort of upside on that -- the elements. But that's all the sort of macro stuff around what the economy will do or won't do. It's a little bit hard for us to make a call. We know exactly what our -- the cost implications are to deal with some of that passporting issues, and we're fairly well progressed on that.

The next question comes from Matt Dunger from Bank of America.

I had a question on the Employee Share Plans, including the Equatex integration. You've previously talked to mid-single-digit growth medium term for the outlook for that business. Here, you're talking about focusing on expanding the customer base and upgrading. Is there room for you to do better than that sort of mid-single-digit underlying growth in Employee Share Plans over the next couple of years?

Yes. Look, it's a good question. So we are in a period of transition within that particular business. We're rolling out the platform across Europe at the moment. That gives us more opportunities to sell more products to both existing and new clients. We'll have a technology offering in the marketplace by the end of this year that will -- which will be very, very strong and is resonating very, very well, so that should help with the growth. I mean the challenge with Employee Share Plans is you've got to have a look at the revenue mix. There's the fee revenue from the clients, and there's going to be the transactional revenue. And the transactional revenue is a little bit dependent on what equity markets are doing. And pleasingly, because of strong equity markets, that transactional revenue has been very, very strong. I think that we still have a couple of years of hard work ahead of us rolling out the platform on a global basis, but I'm confident that as we do that, not only do we get sort of global-based cost synergies, but we'll have a really strong offering in the marketplace. And we can target growth returns that are higher than the mid-single digit. A lot of the mid-single digit comes from the underlying structural growth on the number of units being issued by corporates around the world as at around about an average of 6% -- 5%, 6% on a global basis, higher in Asia and China, slightly lower in the U.S. So that's sort of an underlying structural growth factor that we use. So there are opportunities, no doubt, in that business. I think that we have a very, very focused team. We know exactly where we're going with that business, and it's pleasing to see that the Equatex transaction is sort of outperforming our expectations so far.