As many in the market suspected, with the Reserve Bank flagging an official cash rate that could remain static at very low levels for a couple of years, margins earned by financial platform providers such as Netwealth ((NWL)) and Hub24 ((HUB)) could be squeezed.
ANZ Bank ((ANZ)) has raised the issue in the minds of investors by providing a 12-month notice period to terminate the current pool of cash deposit arrangements with Netwealth. Any re-pricing is likely to have a material impact on earnings as cash margins drop straight into EBITDA (operating earnings) for both Netwealth and Hub24.
The move was not unexpected, Morgans asserts, although no new terms have been agreed, which infers ANZ is looking for a change in the rate provided. Netwealth remains in negotiation with ANZ as well as other banks.
ANZ is the primary banker to the sector, providing similar arrangements to most specialist platforms. Morgans calculates retail term deposit rates are a fair proxy for the current rates the major banks will be looking to provide the platforms and, based on term deposit rates, ANZ is likely looking for a significant reduction.
As Goldman Sachs notes, both platforms have delivered strong growth in funds under management and administration (FUMA) in recent years and typically cash has represented around 5-10% of this over time.
Both pay interest to customers that leave cash on the platform and generate this interest via passing cash through to a bank as a deposit. The current agreement provides Netwealth with 95 basis points over the cash rate on deposits.
Goldman Sachs points out domestic banks can raise retail term deposits at around 30 basis points above the cash rate and 3-5-year wholesale funding at around 50 basis points. Hence, the Netwealth contract was becoming relatively expensive.
Citi had expected ANZ would lower the rate offered to both providers, given the low cash rate environment. With Netwealth and ANZ not yet agreeing on a new rate the main uncertainty centres on what cash margin Netwealth will ultimately end up with.
Assumptions
Citi, having already assumed a -25 basis points compression in cash margins, increases this to -40 basis points for Netwealth and -30 basis points for Hub24 and now expects both companies will earn around 65 basis points on platform cash balances.
Upside exists if the RBA increases the cash rate. Industry consolidation should also result in more rational pricing. Competition from new entrants remains a risk, although Citi notes new operators typically take time to gain traction.
Goldman Sachs moves to an assumed cash rate plus 50 basis points for both and estimates for earnings per share (EPS) are downgraded for FY21-23 by -0-15% for Netwealth and -1-10% for Hub24. The broker anticipates the agreement with Hub24 should insulate earnings for a little longer as it is contracted to the end of the first half of FY23 (December 2022).
While its downgrades are not insignificant, the broker emphasises the growth profile of both platforms remains strong. Hence, the market is likely to return its focus to the medium-term outlook for growth in FUMA and margin optimisation, both of which remain encouraging.
Morgans factors in a -30 basis points reduction in the deposit rate for both Netwealth and Hub24. The broker calculates, all else being equal, every 10 basis points move away from its assumption affects FY23 estimates for EPS by 4% for Netwealth and 5% for Hub24.
Value
Citi believes downside risk is limited for both stocks and a reduction in cash margins to more sustainable levels will actually remove one of the key bear points hovering over the sector. The broker has upgraded Netwealth to Buy and maintains a Buy rating on Hub24, expecting solid earnings growth will continue as market share increases.
Netwealth has less execution risk, in the broker’s opinion, as Hub24 has to integrate recent acquisitions, yet the latter has higher earnings leverage. Morgans retains an Add rating on Hub24 but a Hold rating on Netwealth because it is trading close to fair value.
The broker expects both companies will continue to gain significant market share and deliver ongoing long-term growth. Ultimately, both can also absorb the impact of a rate reduction and still deliver substantial growth.
JPMorgan, not one of the seven stockbrokers monitored daily on the FNArena database, is more bearish, retaining Underweight on Netwealth with an $11.80 target and downgrading Hub24 to Underweight, with an $18.30 target, assessing both are exposed to re-pricing risk. Goldman Sachs, also not one of the seven, retains a Buy rating on Hub24 and Neutral rating on Netwealth with targets of $24.58 and $15.18, respectively.
The database has three Buy ratings and two Hold for Hub24. The consensus target is $25.37, suggesting 19.6% upside to the last share price. The consensus target for Netwealth is $16.01, suggesting 17.7% upside to the last share price. There is one Buy rating (Citi) and four Hold.
