Class Makes Progress Despite Competition

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Strong uptake in cloud-based SMSF software continues to underpin the outlook for Class although competition has put pressure on margins.

-Flat margin outlook as a result of higher costs until July 1
-Cycling out of AMP contracts a headwind
-Recent SMSF reforms constructive for Class outlook
 

By Eva Brocklehurst

Class ((CL1)) withstood difficult operating conditions, reporting first half underlying profit growth of 19%. Stable growth in licence fees from existing clients using the fund administration platform underpinned the result.

There remains strong uptake in the company's cloud-based SMSF software, although average revenue per unit fell and customer acquisition costs increased. UBS is not surprised at the latter outcome, given an aggressive competitor offered fee holidays which the company matched in the period.

The broker prices in compound growth rates of 20% for FY19-22, considered priced into the stock. Class has guided to flat earnings margins as a result of higher costs until July 1, 2018 for many accounts. More development costs were also capitalised in the first half.

The company has flagged the risk that implementation costs will grow in line with, or faster than, sales, as a result of competitive intensity, amid attempts to capture cloud conversions from its major competitor.

UBS considers the chance of another fee holiday in the second quarter of FY19 remains elevated but expects the company to lift it share of the SMSF market to around 45% over the next decade while average revenue per unit will be flat.

Morgans notes profits would have been significantly better had there not been confusion in the accounting industry on how to implement changes to superannuation fund rules. The company expects this will slow the rate of new accounts being signed up until the first quarter of FY19.

Despite the short-term setback, Morgans believes the company will take market share and return to double-digit growth rates, as it benefits from regulatory and compliance requirements that will force most SMSFs to migrate record keeping administration to cloud-based platforms.

Class is one of the two major cloud-based SMSF administration platforms and also the fastest growing. The broker suggests the company is on track to deliver full year net profit between $8.5-9m and believes this will be a good outcome, given the issues that are affecting the company in FY18.

These include the need to make special offers to win new accounts, higher selling costs and the moving of some 9,500 client accounts from Class by AMP ((AMP)) to its own technology.

Margins

The first half revealed a re-basing of margins. The main driver is a more competitive backdrop that has inflated the cost of customer acquisitions. Some improvement has been flagged but Wilsons believes the re-basing could be permanent and now assumes flat margins.

The broker downgrades margin estimates by -6-8% for FY18-19. The competitive landscape is more restrictive but at the same time the fundamentals attractive and the broker would use any weakness as a entry point for the stock.

Wilsons, not one of the eight stockbrokers monitored daily on the FNArena database, has a Buy recommendation and $3.03 target. The broker suggests the recent regulatory changes for superannuation may dampen subscriber growth in the fourth quarter and cycling out of the AMP contract will also create a headwind.

Longer term, the outlook is constructive given recent reforms, and these have driven the need for improved reporting which should crystallise the adoption of technology.

Ord Minnett believes, while margin guidance surprised on the downside, it is not a permanent reduction in profitability. The broker is encouraged by the outlook and believes the company can grow its market share to around 40-45%.

The main offset is that AMP is likely to be moving funds earlier than expected and this will have a negative impact on the second half. Despite this, the broker believes a net addition of 24-25,000 SMSF funds in FY18 is still achievable.

The database has two Buy and one Hold (UBS). The consensus target is $3.20, signalling 13.1% upside to the last share price.

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