Netwealth Sacrifices Margin For Growth

Small Caps | 11:05 AM

Wealth platform Netwealth is moving into the broking space, investing for growth and scale at the expense of near-term earnings margins.

• Netwealth's market update disappoints on FY26 funds flows
• Future outlook now hinges on a major new deal with Morgan Stanley Wealth Management Australia
• Investing in growth means near-term margin pressure
• Management confident the platform can sustain its FUA growth profile out to FY30

By Greg Peel

Netwealth Group ((NWL)) is an Australian financial platform operator offering superannuation, retirement, investment and managed account facilities. 

Shareholders have witnessed the shares appreciating from below $10 ten years ago to above $23 today, though the price peaked above $37 in August last year.

The potential threat from AI had placed software companies, including financial platform operators, globally in the too-hard basket.

Management this week announced FY26 net flows of $15.4bn, implying June quarter flows of $3.2bn, -15% down year on year and -19% below consensus.

Netwealth believes the downturn was due to "Middle East conflict, associated market volatility and recently proposed tax changes" but views the impact as temporary.

While such impacts were somewhat anticipated, management noted this was largely weighted to June, implying a much softer exit.

Management’s view is the impact here is temporary, though UBS notes the last cyclical episode (June quarter FY22 to March quarter FY23) saw flows down some -30% year on year for a period of twelve months.

Investing for Growth

Notwithstanding the risk of more persistent cyclical softness, Netwealth’s FY27 flow guidance of $18bn-20bn, 12% above consensus, will be underpinned by growth initiatives.

As part of an expansion into adjacent Broking and Private Wealth markets, which offer a total addressable funds under management (FUA) market of $600bn over 55-plus brokers, Netwealth announced an agreement with Morgan Stanley Wealth Management Australia, which has $40bn of assets under management.

Growth in this segment will partly underpin ambitions to double FUA by FY30 across both Custody and iHIN (integrated Holder Identification Number), driving 16% compound annual revenue growth on UBS’ revised estimates, but at the expense of a more subdued margin.

Some of the FUA growth target is underpinned by the new agreement with Morgan Stanley Wealth Management, but Ord Minnett also expects underlying organic growth.

Striking the right balance between growth and margin has been a key debate among analysts and investors. The investment in growth initiatives will see margins fall -2 percentage points to 47% in FY27 before gradually recovering back "towards 50%" by FY30, compared to prior consensus' estimate of 51.5%.

Netwealth's recent reinvestment strategy had left some investors questioning whether incremental reinvestment would generate meaningful returns, Morgan Stanley (the broker) notes, especially given the circa 40x FY27 PE multiple the shares are trading on.

The Morgan Stanley (Wealth) announcement implies an acceleration in net flow in FY27 to be sustained above consensus expectations to FY30. Morgan Stanley (the broker) sees the net flow momentum as the reason behind the positive share price reaction on the day.

Netwealth sees the broker opportunity ($600bn TAM) implying scope for further wins. Perhaps more importantly, Netwealth now has confidence it can sustain its FUA growth profile out to FY30 ahead of consensus.

In the past, the market has rewarded the ability of platforms to build scale.  Investors again seem willing to accept the -2 point step-down in FY27 earnings margins given the improved net flow outlook.

Netwealth also flagged a meaningful step-up in capex (almost three times FY25 levels), including replacing ageing, not-fit-for purpose technology with a modern platform, which Morgan Stanley assumes is sustained going forward.

Morgan Stanley feels the strategy of widening the feature gap versus legacy players and driving scale makes sense given Netwealth only enjoys single-digit market share. Management indicated a maximum three-year target payback on reinvestment, implying scope for further revenue upside if successful.

Morgans expects the capex investment is largely front-ended to capitalise on the broker opportunity and ultimately drive long term scale benefits from the incremental flows/revenue, which should support management’s targeted return to 50% margins over the four-year horizon.

Margin Pressure

Further out, the additional flows from Morgan Stanley (Wealth) and other potential wins should enable a solid pathway towards Netwealth’s ambition of doubling of FUA by FY30, albeit this will be slightly dilutive to revenue margins.

Flows from Netwealth’s broker offering will likely see a shift in unit economics and scale benefits compared with those traditionally seen in the company’s custody-based platform flows.  

Morgans anticipates requirements of broker-based accounts will vary and, as such, the unit economics of these deals are likely to incorporate a mix of FUA that attracts some custody, reporting and administration-based revenue (akin to Netwealth’s traditional model), as well as FUA on a flat-fee-per-account model tied to iHIN uptake.

This mix will likely place incremental pressure on revenue margins in the near term as flows composition shifts over time.

Long term, Morgans sees the potential for iHIN-based FUA to convert to higher margins over time, should they opt into the capabilities across the platform.

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