Computershare Limited (CPU) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Computershare's First Half FY '23 Results Conference Call. I have Nick Oldfield, our CFO; and Michael Brown from our Investor Relations team with me. And on this we'll take you through the highlights of the results and the outlook for the second half of the year. As usual, we have released a presentation pack to the ASX, and it's on our website. And I'll focus my remarks on the key highlights in the opening pages. Nick will then take you through the financials in more detail. And following the presentation, we'll open the line for Q&A. And finally, just to remind you, we will be talking in constant currency and U.S. dollars, unless we state otherwise. So let me start with some highlights. And let me assure you, I did not get ChatGPT to write this. Too many input variables this half. Now management EPS was up 95%. Management EBIT more than doubled and margins expanded to 29%. We have a natural hedge in Computershare's business model, which is very evident today. The model is driving record results in a volatile macro environment. As interest rates lifted across all our major markets, margin income increased almost fivefold, offsetting inflationary effects on costs and the impacts that uneven market backdrop has had on transaction and event-based revenues. Now the first half was an abnormal period. The combination of the rapid frequency of rate rises and the corresponding impact that had on customer confidence, led to unusual financial results for Computershare. This backdrop and volatility caused what I would term as temporary reductions in event and transaction activities. Our IPOs were down over 70%. Share plan trading was initially impacted and bond and debt issuance slowed. However, we are now returning to a more regular operating rhythm as we enter the second half. Now in the first half, management revenue was up 34%. And on Slide 3, you will see some further detail. Over the years, we have purposely built an integrated business model with a portfolio of recurring core fee revenues, cyclical event and transaction revenues and large client cash balances, which generate margin income. All 3 streams are inherent parts of the model. Margin income is a central part of the underlying operating businesses. It's not just something that sits out on the side, and it is factored in on pricing, contract wins and renewals. Our core fees are highly resilient, recurring in nature, typically contracted and long in duration. They account for over half of group revenue. They increased by 23%, helped by a full 6-month contribution from CCT. Transaction and event fees are more market-sensitive. They account for around 25% of total revenue. Event and transaction revenues were down 14% in the half. Coupled with the impact inflation, EBIT ex. MI was down 40%. These higher-margin activities were volatile, as I explained before And remember, too, all group costs are allocated to EBIT ex. MI. Now that EBIT ex. MI number also includes a disappointing loss in U.S. mortgage services where adverse market conditions worked against us. But the question really is, can EBIT ex. MI recover? We'll guess, in fact, it's already underway. We expect EBIT ex. MI to be down around 20% for the year overall. And you can see that improved second half operating performance in the bridge on Page 6. In 2H, we have the benefits of the usual seasonality, the emerging recovery and Employee Share Plans trading that we've also seen since December as equity markets improved. And we also have the swing to profit in U.S. mortgage services, driven by cost out, MSR sales and return to our traditional amort policy as the useful life of mortgages extends. So let me reassure you that there are no structural issues in the operating businesses. EBIT ex. MI is recovering, and we'll recover further as markets settle, just as we've seen before. Of course, margin income, the third revenue stream, more than offset all of this. We delivered over $350 million of margin income in the half, and we're on track to deliver around $810 million this year. At the AGM, we provided a margin income outlook for 2024. At the time, we expected MI to be around about USD 1 billion. We have now announced the sale of Bankruptcy and Class Actions, which has some balances and applied the most recent interest rate curves. Accounting for these, the 2024 projection is now around $990 million. So what is the strategy with these higher earnings? Well, we will maintain a conservative balance sheet and deploy these cash flows to strengthen our global business, invest in our growth strategy, drive technology innovation and, of course, reward shareholders. And I'm sure some of you may be thinking, well, where is the buyback announcement? Now I would like to see these margin income gains banked and the full CCT integration costs behind us before we take a more active approach to capital management. I also see opportunities to drive our inorganic growth strategy with good acquisitions. And we want to retain the balance sheet flexibility to move quickly as and when the right opportunities present. Now back to the financial details. In the first half, return on invested capital was up 500 basis points to over 15%. Free cash flow was almost $130 million. And the net debt to EBITDA leverage organically repaired by over 30 basis points to 1.33x. In fact, it was over 2x at this period last year. And yesterday, we determined an interim dividend of AUD 0.30 per share, which is a 25% increase on the PCP. Now the payout ratio is 45%, which is within our range. And with our improving balance sheet, the dividend could have been higher no doubt, but we do want to be prudent and retain flexibility to scale and strengthen our businesses. And the Board will review this again in August. The final point I would make is that we are committed to building a simpler, higher-quality and more efficient Computershare. Yesterday, we also announced part of that simplification process. We have agreed the sale of our Bankruptcy and Class Actions business to GCP Capital Partners for a price of $100 million of cash consideration, plus a $40 million to $50 million earn-out payable in total over the next 4 years based on the achievement of some agreed financial targets. Now this business lost money in FY '22, so the consideration is reasonable, and we can recycle the capital into more recurring revenue opportunities. We will continue to review and refine the portfolio. The process to sell the U.K. Mortgage Services business has been interrupted by the market volatility, but talks are ongoing. And in U.S. Mortgage Services, we're also considering other opportunities to improve returns. We can also be more efficient. We also announced the first phase of our new cost out program, Stage 4. Starting with U.S. Mortgage Services, we'll deliver additional gross savings of $40 million to $50 million over the next 3 to 4 years. Now we had a $3 million contribution from this new program in the first half and expect to see a further $22 million of additional savings in the second half. Now let me now move to the outlook, and we show this detail on Page 8. And I'll talk to guidance for FY '23. First, we reaffirm earnings guidance for the year. In August, we expected management EPS to be up 50% this year. And at the AGM, we upgraded our expectations for earnings to be up around 90%. That is unchanged. Earnings for 2H are expected to be around $0.65 per share, and that would be an increase of over 85% versus the second half PCP. Now we have laid out how our thinking as evolved on a couple of the moving parts as ever. The deltas, compared to August last year, so to speak. On the positive side of the ledger, we have interest rates and our recapture rate for 2H, which are better than we anticipated as we successfully renegotiated higher yields with some of our deposit institutions. Our Stage 4 cost out program in the U.S. Mortgage Services, as I said previously, is gathering pace. And also in U.S. Mortgage Services, our MSR portfolio has increased in value and useful life has extended. And the market value of the book is now in line with the IFRS book value. Therefore, we have returned to the original U.S. amort policy of 9 years, effective the 1st of January. But as evert, there are some things going the other way. Client balances are likely to be lower in the second half, mainly due to lower corporate actions volume and, of course, timing on closing on today's disposal. The EPS impact of the sale of Bankruptcy and Class Actions, which we expect to complete in May, however, we should be able to absorb that. And finally, employee share plan transactions are running below previous expectations. However, again, as I said earlier, our 1H exit run rates were much improved. However, we're likely to be down overall for the year. So overall, these swings and roundabouts net off in FY '23 and guidance is reaffirmed. I'll now hand over to Nick to take you through the financials in a little bit more detail.

Thank you, Stuart. I'll start with our financial results on Slide 10. Our total revenue for the group increased 33.5% over the prior corresponding period, whilst revenue, excluding margin income, was up 9.3%. Legacy operating revenues fell 5.2%. As you've heard, this was in market-driven transactional and event revenues across Corporate Actions, Bankruptcy, Employee Share Plans and U.S. Mortgage Servicing. Encouragingly, recurring revenues improved to 83% helped by CCT. Margin income increased 467%, reflecting the rapid rise in global interest rates. Excluding CCT, margin income would still have been 245% higher. Total costs were up 18.4%. Again, this includes an extra 4 months of CCT. Assuming we'd owned CCT for the full prior corresponding period, costs on a like-for-like basis were up 4.9%. The majority of this uplift was effective October 1, 2022, when we implemented our annual employee merit increases. And accordingly, there will be further cost increases in the second half, reflecting a full 6 months of the higher employee salary base. You can see this in our 1H to 2H bridge. EBIT doubled to $447.8 million, and the EBIT margin improved 970 basis points to 28.6%, both largely attributable to the higher margin income. Excluding margin income, EBIT was down 40%. Transactional and event revenues tend to be higher margin than our ongoing core client fees, whilst EBIT ex. MI also bears the full weight of the inflationary impact on our cost base. We do not attribute any costs to our margin income revenue line despite the integrated nature of our business model. Interest expense almost doubled to $56 million. The average cost of debt in the first half was 4.35%, and we expect this to be higher still in the second half as rates continue to rise. Now to be clear, all of our debt is at floating rates so as to act as a natural hedge to our margin income in the event rates fall. As you'd expect, income tax expense was also higher, more than doubling to $119.3 million, whilst the ETR increased to 30.5%. This was largely due to higher levels of cash repatriation from Canada, where we pay a 5% withholding tax payment. It should be a little lower in the second half, reflecting less cash repatriation. Management NPAT was up 95% to $272.2 million. And similarly, management EPS was up 95% to $0.451 per share. Now statutory results are on Slides 49 and 50. Statutory NPAT was $177.1 million, with the difference largely attributable to the amortization of non-MSR acquired intangible assets of $35.1 million, acquisition-related expense of $30 million, $11.8 million associated with our cost out programs and $12.3 million related to the impairment of our U.K. Mortgage Services business. Slide 11 provides more detail on our margin income result, and this was $344 million for the half, $352 million in constant currency. Balances were down $2.2 billion on the prior half, largely nonexposed balances in CCT and Corporate Actions reflecting lower market activity. And staying with margin income, I'll now take you back to Slide 9 and talk about the outlook for the rest of the year and into FY '24. We're expecting around $810 million of margin income in FY '23, and this implies a further $458 million of margin income in the second half. Rates have been rising through the first half, and we're now factoring in just one more rate rise in the U.S. in March in our forecast. You can see the average rates used in the table on this slide. They are all sourced from Bloomberg as of Friday, February 10. And we now expect average balances for the year to be just over $36 billion, and this reflects a further reduction in the second half. This is primarily due to runoff of SPAC balances and lower levels of bond issuance in CCT. Looking to FY '24, we are projecting some $990 million in margin income, a yield of 291 basis points on average balances of $34 billion. And this balance figure, to be clear, reflects the closing of the Bankruptcy and Class Action sale in May. So let me just take you through our FY '24 rate assumptions. First, exposed rates are a function of Central Bank cash rates and the rate at which we recapture that rate from our network of banks, we expect that recapture rate to continue to be around 90%. Second, hedged rates are a function of the fixed rate deposits and interest rate swaps in place at the time and their overall tenor. You can see the rates and the runoff of these hedges on Slide 55. To be clear, we have not assumed any more hedging in these numbers. And third, the non-exposed rate is essentially a blend of client-negotiated interest sharing and giveback arrangements across all our business lines. Going back to hedging. We've currently got around $8 billion in place, and we expect to add more as we go forward. Our aim is to stabilize earnings to the extent that we can, subject to liquidity requirements. We think we have capacity to do another $2 billion to $4 billion of hedging over the next 6 to 12 months. There's more detail about balances on Slides 52, 54 and 55. I'll now talk about operating costs on Slide 17. And here, we show the bridge in operating costs between 1H '22 and 1H '23. Like most companies around the world, we've been impacted by inflation in all our major operating markets. And so we've set out clearly what this has cost us in the half, $52.2 million in the legacy business and a further $7.5 million in CCT. We also show the offset from our cost out programs, which yielded $9.7 million of gross benefit in 1H '23. Our new Stage 4 cost out program will deliver $40 million to $50 million in savings over the next 3 to 4 years, of which $25 million will come through this fiscal year. This is all in U.S. Mortgage Servicing and is a key part of returning this business to profitability in the second half. Now this program was also responsible for $3 million of the $9.7 million first half cost out benefit. Equatex and the ongoing Stage 3 program made up the rest. Now, overall, our operating cost base was $1.0149 billion, an increase of $157.5 million or 18.4% over the pcp. Of course, this increase includes the extra 4 months of CCT as well. The legacy business was up 6.4%, whilst inflation within CCT was a little lower at around 4.3%. I'll finish with some comments on our balance sheet and cash flow on Slide 18. Now in the period, we generated $247.5 million of net operating cash flow, representing an EBITDA to cash conversion rate of around 46% at actual rates. Free cash flow was $128.3 million. Net spend on MSRs was $102 million. This was higher than intended as we deferred a couple of recycling trades to the second half. For the full year, we still anticipate net MSR spend to be in the region of $65 million to $70 million, which will help us bring the invested capital in that business back down to our targeted levels. Net debt is $1.26 billion at the half. Now this is slightly higher than at year-end, reflecting the acquisition of those MSRs and the investment in the CCT integration and our ongoing cost out programs. But with earnings growth and deferred capital recycling trades occurring in the second half, we do expect a much lower net debt position at year-end. I'll now hand back to Stuart.

Thank you, Nick. So as you have heard, we have confidence going into the second half. Computershare is performing strongly, and the model is working well, delivering record results for the half with more to come. Margin income gains are also very welcome, of course, and we will use the cash flow wisely. But we also are focused on building more recurring fee revenue across the group, strengthening our moats, using technology to become more efficient, adding more value to clients and of course, simplifying the portfolio. Thank you for dialing in, and we will now open the line for questions.

[Operator Instructions] Your first question comes from Ed Henning with CLSA.

I've got 2 questions for you. Firstly, in the presentation, you mentioned the U.S. Mortgage Servicing business. The Market Day is now aligned with the IFRS book value. Can you just tell us what that book value is currently? And if you are potentially looking to sell this business, is the book value of the MSRs a key driver of valuation? And given rates are high at the moment, is this the opportune time to look for a sale? That's the first question, please.

Thanks, Ed. So if you look at our invested capital slide in the appendix to the deck, you'll see the latest position, which has -- that includes the book value of the MSR portfolio. And that book value, which is the IFRS book value, is in line with the U.S. GAAP value. Now these businesses, to your point, generally trade on a multiple of net asset value. And so that invested capital position on that slide is a good proxy of what the business would be worth, subject to any multiple on top of that. I think if you -- I'll just read out the actual number. So you see invested capital was $793.9 million at the end of December. So that's a reasonable proxy.

Okay. And then you've got potentially -- as you say, obviously, you've got the business on top of it and the non-ancillary revenues that would be potentially something on top of just the book value of the MSRs?

Typically, these businesses on a multiple to book value. So you might expect that it would be worth one and a bit times net book value.

Okay. Okay. No, that's helpful. And potentially, if you are looking to sell this business, given where rates are, is this the opportune time to look for sale?

Yes. Look, I think it is. I mean part of that is the value of the underlying MSRs. Obviously, as mortgage rates have increased in the U.S., origination is low. Therefore, the amount of MSRs coming to the market is a little bit lower, which just sort of drives the price up a little bit. So certainly, it's a lot better positioned than it was 18 months ago, Ed.

Yes. Yes. No, that's very helpful. And then just a second question on issuer services. Both the issuer paid and the broker paid fees were down on the pcp. Can you just touch on the outlook there? Was that -- is there some transactional revenue in there that should be bounced back? Or do you expect to see growth in the second half or even in '24? Or are you winning market share there?

Yes. So look, the issuer paid fees are a combination of sort of core registry fees, Annual General Meetings of fees and also recoverables. They were pretty flat year-on-year. And the reason -- one of the main reasons why they were flat was because, normally, we replenish through IPOs, which not only do you get a little bit of corporate action type revenue with the IPO, you then get that annuity revenue going forward, and they were down. So that puts some pressure on that line and held it flat. In terms of the holder and the broker paid fees, I think that it was down roundabout certainly less than 3% overall. And that's a little bit to do with equity markets, and because there is some trading in there. And then also some of the broker fees, there -- especially in the U.S., the DWAC fees, for example, like the number of DWACs throughout that period were down 20%. Now we had forecast that we would be down, and we were able to actually increase the pricing of these. But just with timing didn't quite net off. I mean nothing underlying structural, just a little bit what I talked about in terms of how the sort of equity markets were in the first half of the year.

Your next question comes from Kieren Chidgey with Jarden.

A couple of questions, if I could. Maybe just starting, Stuart, on sort of the profile for EBIT ex margin income into second half. You've highlighted in the waterfall, the bridge, both seasonality and sort of operational improvements. Just wondering if you can impact more at a segmental level where sort of outside, I guess, that incremental cost out benefit you've flagged in mortgage services? What else sort of drives that confidence in the second half outlook?

Yes. So I mean we've always had seasonality in Computershare. As part of a bigger group, it's probably a little bit profound. But part of that seasonality is the sort of larger meeting season through Issuer Services in the Northern Hemisphere. We are seeing a number European companies drag their AGMs, which typically July, August into sort of May and June, which sort of brings that forward and certainly into the second half. Operational earnings growth, we estimate just over $0.06 in the second half. I think I mentioned earlier, we do have that pretty reasonable exit run rates on the Employee Share Plans trading. Certainly, the first of 5 months of FY '23 with the way equity markets where that was consistently down. But we're seeing sort of reasonable sort of a recovery in that through December and certainly January and also the first initial trading days of this month. So that really goes to some of that sort of operational earnings growth across the business as an example. I mean the U.S. Mortgage Services returned to profitability. That's really the cost out program that's quite specifically in that one there. As we mentioned, slightly lower amort charge for that particular business as well. So look, I think, as I mentioned, the first half was fairly abnormal for Computershare. And so much that the velocity of rate rise is happening so fast, booked a number of markets. And it's not about rates have to come down for those to return, it's much more about stability, more than anything else. And we can see that sort of picking up a little bit. So we'll see slight improvement seasonality, a little bit more into corporate actions compared to what we had. Employee share plans returning, and then the factors that I called out in U.S. Mortgage Services, which are fairly pleasing. Most of them are actually within our control for a change, Kieren, so. That's why we've got confidence on that.

Okay. And secondly, just following up on U.S. Mortgage Services. You've outlined additional cost savings. There's been some UPB growth and the amortization charge is changing and expect, I guess, some sell-down of MSRs coming through in the second half, which reduces the capital base. All that in the mix, what should that be producing in terms of ROIC outlook sort of heading into '24 and sort of how is that sitting relative to your target or requirement for the business?

Well, I think in the second half, the first objective, Kieren, is to get the business back to profitability. But assuming that we can deliver our -- we can deliver that return to profitability coming through '24. And assuming market conditions stabilize somewhat so that we see a return of -- a return of those transactional items if you look at all the sort of revenue line, servicing-related fees in that business, assuming that they come back to more normal levels, then I would expect in FY '24, it would be delivering a ROIC more in line with where we would target our business to be, particularly given where rates are.

Okay. And sort of is that ROIC kind of what it was a number of years ago in the sort of like current [indiscernible]?

Yes. So I would expect -- yes, FY '24 should in the 12 months. We've always said that if we annualize 12 months coming into COVID, we were right bang on our return targets in that business. And I'd expect, all things being equal, that '24 should be close to that.

Okay. And just to clarify sort of that outlook with Stuart's sort of comments around it being an opportune time to consider selling the business. Can you just sort of provide a bit more clarity on strategically whether or not you are likely to or are considering divesting the business at the current point?

Yes. Again, the challenge we've had with Mortgage Services over the last sort of 18 to 24 months is a number of factors really out with our control macro factors affecting that particular business. And I've kind of described it as whack-a-mole at times, right? When -- just when you think something happens, a regulator comes in and changes it. I mean the overall outlook of it is a little bit more positive. The growth in the second half are all things that we can control. Even though originations are down, that's got a little bit of an impact on our fulfillment business. And refinances are, obviously, down because mortgage rates are up, which is affecting some of the recovering rate revenues. But servicing revenues are on the improve, margin income is on the improve. And the value of our MSRs is good. As you can see, we continue to deploy capital into growing that. We will expect to -- we called out that we'll do some MSR sales. I think that we are carrying out a sort of strategic review on the portfolio. We talked about simplification. We are not in a process to sell that business at the moment. But like many of them is under review, and it may well be an optimal time.

All right. And just a final question, Stuart, sort of on your capital management comments sort of that it's too early to consider buybacks. Just wondering if you can clarify. I think one of the things you mentioned there, aside from collecting the margin income with CCT integration. So how far through do you need to be before you sort of deploying -- redeploying that balance sheet, perhaps into capital management? And also on the acquisition side, where you clearly flagged the interest. If you've refined or changed sort of some of the areas you're looking at in terms of potential deal flow?

Sure. So just in terms of CCT integration. So as you remember, we've got quite considerable standup costs. We had sort of regulatory costs, et cetera, et cetera, which was just north of $200 million. Now a major chunk of that is going to be spent over the next 8 to 9 months. The transition services agreement completes in November this year. We have already commenced moving systems, building our platforms and moving data across into the Computershare environment, and that is tracking well and a little bit part of the synergies. But we've got a chunk of change that we have to deploy this year up to November, right, in terms of these costs. I think there's probably close to $140 million roughly from memory that will be spent on standing up CCT for the remainder -- well, certainly this calendar year. So that goes to a little bit of timing. And as I say, I think it's prudent that we -- that is money at the door. And I want that to see behind us. The other part of that question, which is really about where we're actually able to deploy capital, clearly, issuer services, employee share plans and our corporate trust businesses are really the areas that we want to focus on to strengthen, increase our moats, drive some inorganic. There are some opportunities there. And then holistically, we've got to look at the large amount of margin income that we're getting just now. And even though rates invariably will move around in the future, we'll go through a period of trying to bring that exposure to the group a little bit down and increase our recurring revenues. So that's really going to be the sort of the focus for the group, which is just all about long-term sort of planning and improving overall Computershare.

Your next question comes from Andrew Buncombe with Macquarie.

The first one is in relation to issuer services margins for the second half. Previously, I think you said that your expected margins in that division to be higher in '23 than '22, but with what you've printed in the first half, how are you thinking about those in the second half?

And when you talk about margins, you're looking at it with -- including margin income because?

Excluding. Sorry.

Well, I mean margin income is very much part of that business, right? And as I talked about earlier on, there was certainly certain components of equity markets and capital raising that sort of brought that down in the period as a fairly abnormal period. I know that our issuer services team, when they're talking with clients, renewing contracts, bidding for contracts, margin income is an important part of that. And even while headline rates are high, you look at our sort of FY '23 exposed balances. They really just sort of mid-cycle interest rates at the moment, and margins are improving. I don't think it's quite right that looking at that sort of abnormal half and challengingly where the margin went in that particular period because it was a little bit unusual. And you should include margin income certainly in issuer services because it's really quite core to the operating structure of that business.

Yes. Understood. The next one is a similar question on CCT. Previously, you expected EBITDA in that division of close to $450 million this year. How much are you thinking -- how are you thinking about that now that margin income is so much higher?

I think these estimates were with the margin income yield curves at the time. And the yield curve seem to be sort of moving around a fair bit. Certainly they softened through January a little bit. But then it seems like every day, there's a different view and a different opinion on where we're at. I think it's clear that there's further rate rises to come, although there'll probably be a little bit more stable. And I think that's really good for the CCT business because that will actually improve the trust fee revenue because markets will be stable. Debt and bond issuers will know where they're going. So I think that we're on track to be able to deliver that EBITDA this year.

Excellent. And then just a final one from me, please. How should we be thinking about the bounce back in ancillary revenue in the U.S. Mortgage Servicing business? And what have you assumed in guidance for '23?

Yes. Look, we clearly have factored in what we think on that. On that ancillary revenue, the biggest impact there is really in something that we call recovery fees. Now recovery fees are obtained when a loan is refinanced, right. So it's when someone is refinancing a loan. Perhaps they missed a few payments. Refinancing, we get a set of recovery fees. One of the challenges in that market at the moment is, clearly, mortgage rates have increased again fairly rapidly as base rates went out. And it's a little bit harder for some of these customers to actually refinance at the moment. And therefore, recovery fees are not as strong as what they were in the height of recovery. But again, I think that will settle down over time.

Your next question comes from Simon Fitzgerald with Jefferies.

Just on starting point on mortgage services. I understand that it's an opportune time to now look at selling the U.S. business. But we're now at a stage where it's the highest level of invested capital, despite the fact that it's the largest recorded loss on history. But I guess in the absence of being able to sell the business at the moment, what level of capital do you think you can bring that down to? And then I guess, also, I'm interested to know a little bit more about the advances, which have gone up substantially over the half. And whether you expect those to continue to go up, just given the sort of outlook, let's say, mortgage repayments in the states? I've got a couple of other questions after that.