Australia | Oct 30 2013
-Bottom line weakness prevails
-Compliance issues will diminish
-Still looking for new CEO
By Eva Brocklehurst
Just when SAI Global ((SAI)) looked like making up ground and stabilising its business, another downgrade to forecasts comes along. At the AGM the information services and standards auditor announced that revenue growth would be 8-10% in FY14. Earnings would nevertheless grow at a lesser rate and profit would be flat. The contributor to the bottom line weakness is long-running issues in the compliance services division.
UBS is a little exasperated. This is the fifth time since February 2012 that guidance has been provided below consensus expectations. Incorporating the guidance means the broker has raised revenue forecasts, having expected 5.5%, but downgraded earnings forecasts, having expected 8.5%. Now FY14 earnings per share estimates are reduced by 7% while earnings estimates are reduced by 4%. The broker thinks the market is likely to become frustrated with the lack of earnings visibility, which could result in the share price coming under pressure because of multiple de-rating.
Having said that, and relieved the frustration, the broker was content to maintain a Neutral recommendation. Others on the FNArena database are maintaining their ratings for now. In total there are five Buy ratings and three Hold. The consensus target is $4.33, suggesting 6.9% upside to the last share price. This compares with a $4.48 consensus target ahead of the AGM.
Morgan Stanley also acknowledges that operational setbacks are frustrating but the defensive nature of the company's revenue has been underscored by the guidance. The larger revenue base should translate to higher earnings, eventually.
Delving into the divisions CIMB finds, after no growth in the past 18 months, sales growth in information services is finally turning positive. The broker expects 3% growth in FY14. Property services is expected to grow 28% and will be the largest driver of earnings growth in FY14. After a weak period, assurance services are expected to return to growth around 5% in FY14. So it's mainly compliance services, where CIMB expects earnings to fall 13%, where the weakness lies.
CIMB also observes that with positive revenue trends, the management incentives which were absent in FY13 have now been reinstated on expectations that FY14 budget outcomes will be met. This has added to costs and reduced the bottom line. CIMB has reduced earnings expectations across FY14-15, with nearly 30% of this revision relating to lower FX benefits because the main currency exposure, USD/AUD, has rallied from August lows. The remainder of the reduced earnings is the increased incentives. SAI recently downgraded the aspirational target for compliance services margins to around 35% from 38-42% and, as CIMB has not factored this into forecasts, it represents upside earnings risk.
SAI is suffering from spending over $400m in acquisitions since 2007 with the bulk of these in the compliance space, notes to JP Morgan. They may have added capabilities and expanded the geographic reach but the integration has been costly, culminating in a $90m impairment charge in FY13. The turnaround is expected to take another 12-18 months. Macquarie believes margins will be dragged down by operational issues and cost increases for a while yet but when sorted should translate to higher margins and earnings growth. The stock's valuation is not stretched and the broker is comfortable with an Outperform recommendation.
The investment thesis is still intact and that's enough for Deutsche Bank to retain a Buy rating. The business is achieving improved revenue and the negatives relate to higher cost investment and delayed earnings recovery. Compliance client issues are now stable and the broker thinks the company is implementing a more robust earnings platform.
JP Morgan also observed that the appointment of a new CEO has still not been made. The search has been going on for five months and the broker thinks the uncertainty and timing of the appointment will weigh on the stock until resolved. Current CEO Tony Scotton was to retire by the end of the year but will now stay until March 2014. Macquarie thinks this delay reflects the fact the board has decided to find an external candidate. This is disappointing in the broker's opinion, as the stock is likely to trade with some uncertainty until a new CEO is installed and the changes to operations and strategy are known.
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