Synergy benefits provided most of the growth for Link Administration ((LNK)) in the first half while many of the risks feared by brokers, such as Brexit, failed to score a material negative.
Admittedly, costs and depreciation were higher than Citi and many others forecast but are expected to be temporary. SuperPartners and Link Asset Services synergies should contribute more fully in the second half.
Therefore, the growth story is largely intact. Moreover, changes to super account consolidation should favour Link Administration. Citi also expects a resumption of growth in higher-margin revenue should allow margin expansion to resume in the second half.
Morgan Stanley observes the main concerns that drove a sell-off after the November AGM have eased. These include softness in project fees, which turned out to be temporary as activity rose strongly in the second quarter, and European earnings, despite the Brexit-related headwinds.
Macquarie is pleased that synergy targets of at least GBP15m have been reaffirmed for Link Asset Services and will not be revised downwards following the sale of CPCS, which had been seen as a risk. On the other hand cash flow conversion was very weak and margin trends across divisions were also soft.
Revenue was better while expenses were weaker than CLSA expected, and the improvement in revenue was related to growth in expensed funds administration. Still, the the outlook is now more complex. Issues centre on UK transaction revenue, elevated costs and the need to invest in the business.
CLSA reduces estimates for FY19 operating earnings by -2.6%, with slightly higher negative revisions in the outer years. Still, the broker, not one of the eight monitored daily on the FNArena database, is positive about the stock and retains a Buy rating and $8.50 target.
Deutsche Bank is concerned about the next three years as the business faces account consolidation and lost earnings from the sale of its UK trustee business, as well as margin pressure and downgrades to Sell from Hold as a result.
Ord Minnett goes the other way and upgrades to Accumulate from Hold. While funds administration earnings were weak, the broker notes a pick-up in revenue while a more positive outcome can be expected from legislative changes. The broker finds the current PE multiples undemanding and believes the stock should be a defensive exposure against structural change stemming from the Hayne Royal Commission.
Morgans downgrades estimates by -7-8% on a combination of lower revenue and earnings margin assumptions. The broker notes integration synergies are heavily skewed to the second half and finds the current trading multiple undemanding, not fully capturing the longer-term upside from expansion in Link Asset Services and PEXA, the online property exchange network.
PEXA
Brokers generally assess upside stemming from traction in PEXA as this business becomes a meaningful contributor to earnings. However, while PEXA is likely to make a positive contribution, Citi does not expect this until FY20, and it will be even later before the contribution become sufficient to offset funding costs. PEXA appears unaffected by the impact of the downturn in the housing market.
Credit Suisse believes Link Administration can provide 10% earnings growth over the next 3-4 years, although this may not be linear. Growth should be supported by M&A, synergies, price increases and higher growth in industry funds membership.
Still, D&A is likely to remain elevated into the future and this provides a permanent downgrade to the net profit outlook. UBS agrees with that assessment but suggests, while a step up in D&A is likely, improved revenue momentum and synergy realisation should leave the outlook relatively unchanged.
Regulatory Changes
Management has confirmed legislation for inactive accounts has been passed by the Senate. The definition for such accounts has been adjusted and this will partly reduce the revenue impact on Link Administration.
Morgan Stanley was cautious about funds administration because the business is currently over earning and the number of super accounts is likely to decline, fast tracked by the proposed reforms. However, several developments have changed the way the broker assesses the outlook and these are largely positive.
The first is the delay of 6-12 months in super reforms and the fact these have been watered down, as the definitions have been relaxed. Moreover, a shift into industry funds is afoot and Morgan Stanley believes this structural. Industry funds, historically, have been poor at retaining members that are approaching the pension phase, but have now built retirement products which compete with retail and SMSF offerings.
The Hayne RC has also triggered a mass exodus from bank and insurer-owned funds. The market share captured by industry funds should, therefore, be a permanent feature and help Link enjoy more than 3% growth in members over the medium term, in the broker’s view.
The fact that the company’s largest client, AustSuper, is raising its administration fee by 50% means that Morgan Stanley is more confident Link will be able to renegotiate contract terms. Other funds are expected to follow.
Credit Suisse also has become increasingly confident that Link will be able to offset any headwinds from the regulation of super account memberships. The broker believes Link Administration can provide 10% earnings growth over the next 3-4 years, although this may not be linear. Growth should be supported by M&A, synergies, price increases and higher growth in industry funds membership.
FNArena’s database shows seven Buy ratings and one Sell (Deutsche Bank). The consensus target is $8.06, signalling 14.3% upside to the last share price. Targets range from $6.30 (Deutsche Bank) to $8.60 (UBS).
