-Upside from alternative financial markets
-Positive credit referencing potential
-New ID and risk-based services
 

By Eva Brocklehurst

Veda Group ((VED)) sustained a pullback in consumer credit enquiries in the June quarter but this was not a surprise to brokers. The March quarter was the strongest quarter for Australian consumer credit growth since 2008. Moreover, with supportive changes to Australian consumer law, brokers envisage plenty of opportunity stemming from growth in alternative financial markets.

Macquarie is the latest broker to have initiated coverage of Veda Group, setting an Outperform rating and $2.27 target. The broker is attracted to the diversification opportunities presented by non-financial businesses. Comprehensive credit reporting services provide an added bonus. Veda conducts credit checks on consumers and businesses for the insurance, automotive and property sectors. At 63% of sales, Veda's income is heavily skewed to the traditional financial industry but the company has started to unlock opportunities that exist in adjacent businesses. By comparison, the company's international peers generate 60-70% of sales from alternative markets and Macquarie suggests diversification could drive 5-year compound annual growth rates of 11%.

The financial services industry is witnessing significant disruption from new financial competitors in both the provision of credit and in payments systems. Veda can leverage this disruption by partnering with new networks, in peer-to-peer lending and via retail aggregators, with Macquarie envisaging potential upside of 7-10% of earnings from these product offerings alone. Veda is making inroads into new segments with ID verification and risk-based products and services. UBS believes Veda's growth prospects in the near term will be underpinned by identification services and access to the Personal Property Securities Register (PPSR). The PPSR is the single national source of registered security interests in personal property. Veda has an established search function for the register, called VedaCheck, which saves customers time and money.

Credit referencing is another compelling opportunity. Comprehensive, or positive, credit reporting sounds like it has been around for ages. The fact is that until March this year, following changes to the law, only negative credit data could be collected. Having insights into a customer's credit worthiness enables businesses to evaluate risk more thoroughly. Moreover, a customer's payment history is a strong predictor of future behaviour, enabling marketing potential. Still, Macquarie observes the case for using Veda as a source of credit checks may not be so compelling from the point of view of the main users of credit information - the banks. Achieving critical scale is necessary in the long term for comprehensive reporting to add an extra string to Veda's bow and at present the broker does not include any revenue from this area in valuing the stock.

It would be helpful to have a major bank in Veda's camp. At present none have opted in. In Macquarie's view, targeting the rest of the market means a delay in getting to a level at around 40% of the market that seems necessary for critical mass. The major banks stand to lose some competitive advantage from participating, while the benefits from comprehensive reporting include lower credit losses and increased lending volumes. Australia has few major banks and competition is fierce so there is less incentive to share customer data. Nevertheless, in those countries which have adopted positive reporting, credit bureau volumes have doubled. This represents a significant opportunity for Veda as the incumbent bureau in Australia.

Veda does not have the market to itself. Many of its peers have moved aggressively to leverage credit-based information. Macquarie notes Dun & Bradstreet has a significant non-financial services exposure while Experian has also moved to expand its market position, given its role as a credit bureau in many markets. Areas which provide opportunity for Veda, and where global peers are active, include fraud prevention, corporate and consumer scoring and marketing. If developments go Veda's way Macquarie thinks comprehensive credit reporting will be a game changer, envisaging 30-40% upside for the stock.

The biggest risk Veda faces is security breaches or unfavourable regulatory changes.The business has significant technology and operational risks given the sensitive information that is stored and transmitted to numerous customers through multiple channels. The business is also subject to changes in legal and regulatory requirements from time to time. Veda also operates in the Middle East and Asia. In 2013 Cambodia improved access to credit information by establishing its first private credit bureau with Veda. 

On FNArena's database there are one Buy and three Hold ratings. The consensus target is $2.18, with Macquarie's $2.27 now second of the range, only beaten by Deutsche Bank's $2.35. Citi is the low marker with a target of $1.99. The new consensus target suggests 16.1% upside to the last share price.

Despite the recent pullback, Veda Group shares are still trading on 20x FY15 consensus earnings per share, implying a forward dividend yield of 2.3%.

See also "Brokers Check Out Veda's Advantages" from January 21.

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-Growth in new industries, markets
-Lower funding costs
-Aggressive NZ expansion
 

By Eva Brocklehurst

Flexigroup ((FXL)) has been a stable Buy rated stock for some time on FNArena's database. Despite share price underperformance this year as the market factored in headwinds to credit growth, several brokers believe the financial services provider has been sold down beyond what is reasonable.

Citi has initiated coverage of the stock, mindful of the increased diversity of product and services and the potential for leveraging an improvement in the cost of funding. The company has reaffirmed market guidance of FY14 cash profit of $84-86m and Citi expects earnings growth of 12% in FY14 and 9% in FY15.

The financial services provider offers retail point-of-sale financing, commercial leasing and interest-free credit cards, primarily in Australia and New Zealand. Macquarie considers the stock has de-rated beyond what was necessary to reflect lower growth expectations for FY15 and credit growth headwinds. The stock is now trading, on the broker's estimates, at a FY15 price/earnings ratio of 10.7 times.

Citi envisages three primary drivers for the stock. The first is new industries and end markets. Originally, the company offered single line rental and lease solutions via Harvey Norman ((HVN)). Now Certegy Ezi-Pay, the company's card payments business, has transformed the customer base substantially into diverse segments such as solar panels and jewellery. Certegy acquires receivables from retailers at a discount and offers zero-interest fortnightly/monthly instalments to end customers. Self-managed, flexible lay-buy services are also offered through select partners like Toys "R" Us. Mobile broadband expands the company's offering further, through targeted device-plus-service bundling. Consumer and small-to-medium enterprise leasing comprises 41% of Flexigroup's services. Here, the company's FlexiRent performs real-time credit approvals and acquires trade volume primarily funded by third parties.

The second driver is lower funding costs, partly derived from securitisation. The company has a long experience within the local finance industry and works in conjunction with independent credit reporting agencies. Originally it funded its leasing business via unrated bank facilities and cash. Flexigroup now has four avenues of funding, with securitisation representing 38% of drawn-down funding in the first half of this year, compared with zero four years ago. The company issued $255m in asset-backed securities last month, the fourth securitisation package from the Certegy business.

Acquisitions make up the third driver, providing both revenue growth and a counter to the soft retail markets. Citi observes that generating a critical mass of receivables is key to continue reducing the cost of funding. As volume for the original leasing business continues to decrease, at an average 10% per annum since FY11, the company has focused on expanding categories and end-markets to generate organic growth. The company has also launched an aggressive expansion plan into New Zealand where demand is forecast to increase 15-20% per annum over the next three years. The broker does not think the company will pursue offshore opportunities beyond New Zealand until the businesses are ready to withstand the challenges such expansions present.

Catalysts for Citi include evidence of the leveraging of cost of funds, which has fallen to 6.2% from 9.4% four years ago, and increased traction in new sectors beyond solar, where Certegy first made its mark, such as home improvements. Risks exist in the securing of sufficient funding for new products, or translation of business through product substitution such as in the case of mobile devices substituting computers. Price compression and increased delinquencies are other risks. All these could limit competitiveness and profitability.

The company's 7-year compound average growth rate of 14% for revenue and 18% for profit suggests the business has managed well through the cycles. Calculation of the organic growth rate is a little more difficult given the number of acquisitions the company has made. Profit margins grew to 37% in FY13 from 30% over FY06-09, and Citi forecasts 38% in FY14. The margin increases reflect the shift from the consumer beginnings to a more diversified financial services provider.

Citi adds its Buy rating to the other four on FNArena's database. The consensus target is $4.44, suggesting 27.7% upside to the last share price. Targets range from $3.81 to $5.00. The dividend yield on FY14 and FY15 earnings estimates is 4.8% and 5.1% respectively.

See also Flexigroup Spending To Grow on May 19 2014.
 

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-Compelling revenue growth profile
-Raises exposure to US institutions
-Diversification factored into price?
 

By Eva Brocklehurst

Wealth manager Henderson Group ((HGG)) has fulfilled a long-held desire to acquire a US institutional equities business, obtaining Geneva Capital Management for US$130m up front and propelling its strategy to become a diversified global asset manager.

Goldman Sachs' calculations suggest possible earnings accretion between 3% and 4% and the broker will adjust estimates when the deal receives the necessary approvals. The business has an average management fee margin of 48 basis points and its funds do not generate performance fees. Goldman notes the recent performance of Henderson funds, which have outperformed since inception, has been less convincing, with the mid caps underperforming benchmark on a one, three and five year basis to March 31 2014 and the small caps underperforming on a one year basis. Goldman retains a Neutral rating.

The company scooped at least two ratings upgrades on the back of the news. Citi upgraded to Buy from Neutral, citing the recent pull back in the share price. The broker thinks Henderson's revenue growth is too compelling to ignore. Taking the acquisition into forecasts and marking to market for the first half means Citi upgrades FY15 and FY16 forecasts by 1%. The stock may not be that cheap compared to its UK peer group but its growth profile has extra value, in Citi's opinion. The broker thinks the deal marries strong US retail distribution with Geneva's US institutional presence and Henderson brings a global presence to the table.

Credit Suisse has upgraded to Outperform from Neutral. The broker notes the stock is currently trading at a discount to Australian peers and in line with UK fund managers and this looks conservative, given the growth trajectory of funds under management and higher performance fees. Credit Suisse's rating and positive view on the stock are underpinned by the valuation, strong growth prospects and upside earnings risk. The important aspect, in UBS' view, is that this is not a transforming acquisition that would be associated with significant execution risk. With earnings accretion providing some impetus to an already compelling growth profile, Henderson remains the broker's preferred exposure to the wealth/funds management space. UBS retains a Buy rating and thinks the stock is well positioned for an extended earnings upgrade cycle, assuming stable equity markets.

Added to the up-front price is 5-year earn-outs in the form of deferred and earn-out consideration, giving Henderson some protection against an adverse market performance. The deferred consideration is US$45m and earn-out consideration is US$25m.

BA-Merrill Lynch thinks the deal will bring a new investment style to Henderson as well as improve exposure to US institutions. Henderson has paid 7.2 times the earnings run rate and this is an attractive multiple, in the broker's view. The broker notes extra payments could add another 2.5 times earnings to the price, although admittedly these are payable over the next five years. Merrills thinks the US market is strategically important for those firms aspiring to be end-game players in asset management. A Neutral rating is retained as the broker thinks the company's recent diversification, while lending considerable strength to the business, is fully reflected in valuation. The company needs more time to demonstrate an enhanced growth profile, which could lead to a higher rating

Henderson will fund the consideration from existing cash and now expects to meet its capital requirements without recourse to the regulatory capital waiver during 2015. Geneva was founded in 1987 and has Assets Under Management of US$6.3bn in mid and small cap US equities. On the FNArena database Henderson has three Buy ratings and two Hold. The consensus target is $4.80, suggesting 9.0% upside to the last share price, and has risen from $4.75 ahead of the announcement.
 

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-Higher risk profile
-Leveraged to weak economy
-Uncertain volume outlook
-Capital return potential
 

By Eva Brocklehurst

Genworth Mortgage Insurance Australia ((GMA)) recently listed on ASX and several brokers have initiated coverage, quietly confident in the long-term outlook for the business while accepting the higher risk nature of the loans covered by this type of insurance.

On a relative basis, as the company caters to the most extreme tail events in the residential mortgage market, brokers expect the stock will trade at a discount to financials with similar return profiles. Macquarie notes Genworth Australia has benefitted from higher premium rates, lower risk products and improved underwriting since the Global Financial Crisis. The micro reforms that have been subsequently undertaken have potential to deliver several years of earnings growth, capital returns and an improving return on equity for the stock. This presents an attractive investment opportunity, in the broker's view.

As the Australian housing market has been resilient over the past 15 years, Genworth largely becomes an undifferentiated leveraged exposure to the tail of the residential market, in terms of either an economy-wide slump, period of higher unemployment and limited income growth, collapsing house prices and/or persistent inflation. The share price could react severely to any of these scenarios. In the meantime, conditions are supportive.

CIMB has a number of concerns. None the least is the structural outlook for the industry. As lenders increasingly retain risk in-house, the company's business mix will shift higher up the loan-to-valuation (LVR) curve. The claims outlook appears supportive and the lower-for-longer interest rate scenario should keep delinquencies suppressed. Having said that, CIMB observes the current investor-led rally in Australian east coast property looks somewhat speculative. Heeding recent warnings on lending standards emanating from the Australian Prudential Regulation Authority (APRA), a mild correction is a near-term risk in the broker's view.

Goldman Sachs considers the business is particularly leveraged to weaker macroeconomic conditions, which could drive lower demand for homes in Australia and lower house prices, higher unemployment and insufficient income to pay mortgages. Nevertheless, in the broker's view, these risks are overstated by the current share price, which implies a significant probability that Australian house prices will experience a sharp fall. Goldman observes the company's insurance margin is very strong - even in the "re-provisioning" year of FY12 the margin was 14% compared with Australian major listed non-life insurers at around 10-15%. APRA standards are stringent and so the broker accepts that, despite high margins, underlying return on equity is quite modest at around 10% in FY13.

CIMB notes a high degree of uncertainty in terms of the volume outlook, with a contraction in new insurance written over the medium term. The broader mortgage approval environment remains strong but is also likely to be at peak levels for this cycle, in the broker's view. Moreover, the market's composition is not particularly supportive, led by investors, as first home buyers have faded from the scene. Major customers, generally the banks, are retaining greater levels of risk and CIMB thinks momentum on this front will build while the credit environment is benign.

Mortgage insurers do have a degree of pricing power and relative pricing is important. Over the past four years, Genworth Australia has re-priced rates, but management does not expect to increase rates in FY14. CIMB assumes no further re-pricing but expects the average premium rate will creep higher, affected by the mix-shift to higher LVR business. Goldman Sachs notes, as the older policies run off and are replaced by new higher returning policies, this should provide a progressive improvement in return on equity, translating to around 9% growth in underlying earnings per annum over the next three years. The broker thinks the stock offers good value and the target of $3.45 implies a 16% total return versus 10% for the broader financials. Goldman initiates with a Buy rating.

Macquarie initiates with an Outperform rating and $3.43 target. The broker believes the company has the potential to return capital through optimising capital efficiency through tier 1 and tier 2 instruments and/or adding reinsurance. Taking a relatively conservative view, Macquarie expects 142c per share could be returned over the next three years, boosting an already high dividend yield, should Genworth Australia move to a more optimal capital structure and include additional reinsurance.

The broker is mindful that capital return scenarios are subject to rating agency and regulatory considerations and constraints. Therefore, current forecasts do not factor in any capital returns as these initiatives are highly uncertain. CIMB suspects that, while yield remains in vogue, the stock will be well supported for its dividend flexibility, but swings in sentiment should provide better buying opportunities. CIMB has a Hold rating and initiates with a target of $3.26.

Lenders mortgage insurance is a specialist line that protects the mortgage provider in the event that a borrower cannot repay their loan. Lenders generally use mortgage insurance for loans originated with an LVR ratio of 80% or greater. The product is called a "long tail" because premiums are earned over an 11-year period, in Genworth Australia's case. The two largest providers in the industry are Genworth and QBE Insurance ((QBE)), having roughly 80% of the market. Historically, the product was used by lenders for capital relief and risk transfer. CIMB notes the future of this type of insurance in Australia will become largely centred on risk transfer. Well over half Genworth Australia's share of the market comes from the major banks.

UBS has also this morning initiated coverage of Genworth, setting a Buy rating and $3.50 target. The broker agrees the stock offers favourable cyclical drivers and will further benefit as the pre-GFC years roll off the insurance book.

The FNArena database now shows tow Buys (or equivalent), two Holds and a Sell. The consensus target price is currently $2.90, suggesting 11% upside.
 

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