Australia | Feb 07 2013
– Intuit leaving a big hole
– Competition circling
– FY14 will make or break
By Andrew Nelson
It started last February. That was when analysts' pet Reckon ((RKN)) first started to fall out of favour with brokers. The accounting software specialist had already seen a couple of moves down to Neutral on valuation grounds, but then the month saw a rare FY reporting miss and the stock’s well regarded status started to crumble.
The news convinced Macquarie to downgrade to Neutral. The broker was worried about challenging market conditions and an increasingly stretched looking valuation. The broker downgraded to Underperform just a month and a bit later, this was on news the distribution relationship between Reckon and Intuit would end in 2014. Customer leakage, increased R&D to replace Intuit and a premium to the Small Ords were the driving factor.
This week saw the next move, again after the release of company’s FY report one year down the track from when the cracks started to emerge. The last holdout sitting at Buy was BA-Merrill Lynch, but the broker cut to Neutral yesterday after the company missed the broker’s forecasts by 5%. While margin erosion within the business division was the main culprit, BA-ML admitted the obvious: the imminent removal of product partner Intuit has created uncertainty.
Despite the downgrade, BA-ML continues to see upside in the form of 30% return on capital performance, free cashflow margins of 20% and a buy-back that should help support 12% EPS growth. However, persistently underperforming earnings, uncertainty around what the broker calls the Intuit “divorce” and the looming threat of a tougher competitive backdrop as peers take advantage of current weakness has the broker worried. This cocktail saw BA-ML cut FY13-14 net profit forecasts by 14% and 6%. The broker still thinks the valuation would be looking good, if not for the above.
Deutsche was OK with the result, but the rest of its assessment reads exactly the same as BA-ML’s. Uncertainty surrounding the Intuit license, less favourable industry dynamics etc. The levels of recurring revenue, a sticky customer base, strong cash flow generation and a solid balance sheet are simply not enough of an offset, it seems. However, were the company able to bank the entire $6m royalty payment due on termination of the Intuit license, then 2014 net profit lifts 9.5% and the PE falls to 12.6x. A whole different story, says the broker.
CIMB, also sitting at Neutral, sees an important year ahead for the company. A big rebranding push, increased marketing and the release of new Reckon One product could all add up to major game changers. However, FY14 will be the crux and we won’t really know anything about the company’s mid to longer-term prospects until then. In the meantime, the broker expects 7% earnings growth over the year ahead is achievable, with even more potential depending upon how the licensing issues works out.
Despite finding the company’s FY report reasonably solid and believing the growth rate is sustainable, at least over the near term, Macquarie continue to believe the stock is at serious risk of a PE de-rating given the current 22% premium to the Small Industrials.
Macquarie, still at Underperform, also sees a real risk the company may have to lift its R&D spend to bring them into line with industry averages just to keep up with the competition over the longer term. Peers like MYOB and Xero are not likely to be asleep at the switch and longer term customer attrition thus also remains a real risk.
FNArena's Stock Analysis shows three Hold and one Sell rating with a consensus target for Reckon of $2.34, slightly below yesterday's close.
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