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Morningstar | FactSet Achieving Higher Revenue Growth Despite Industry Headwinds. See Updated Analyst Note from 25 Jun 2019

Wide-moat FactSet produced a fine third quarter, leading us to boost our near-term EPS estimates by 5% and increase our fair value estimate to $182 per share from $163. For the quarter, FactSet earned $2.37 per share while producing year-over-year growth in sales exceeding 7%. Overall, FactSet has been able to shake off any weak 2018 market performance and ongoing industry headwinds. Though we continue to believe that FactSet’s growth will be limited by fee compression at asset managers, the company does appear to be gaining traction within wealth management. Currently, the stock is trading at 31 times our fiscal 2020 estimate. In terms of valuation, shares in FactSet haven’t traded at a similar multiple since prior to 2008. At a price to fair value exceeding 1.6, we continue to believe shares in FactSet are significantly overvalued by the market. Longer term, we see sustained headwinds from passive flows and asset manager fee compression. That said, we will acknowledge it does appear the company is offsetting these headwinds by moving downstream into the wealth manager segment.

On the back of this quarter’s better-than-expected results, FactSet improved its guidance. The company now expects to generate operating margins in the range of 30%-30.5%, a 75-basis-point improvement from management’s previous guidance. Most of this improvement appears to be coming from expense control as the company only narrowed its guidance for revenue growth. During the quarter, the company saw operating expenses in line with the previous year. Much of the company’s savings appears to be driven by sourcing labor from cheaper geographies. In 2018, the company’s median employee compensation was $15,331, far lower than any of its peers. In comparison, FactSet’s closest rivals S&P Global and MSCI had median employee compensations of $26,738 and $41,229, respectively. In addition, FactSet is partly benefiting from a stronger dollar. FactSet investors should view a stronger U.S. dollar favorably since the company’s costs are increasingly weighted toward foreign currencies. We’ll warn any reversal in the U.S. dollar would undo some of the company’s recent margin benefits.

In addition, FactSet is benefiting from lower interest rates. During the quarter, the company’s debt load didn’t change much, but given FactSet’s debt is weighted toward floating rate borrowings, the company’s annualized cost of debt dropped by more than 30 basis points. While we have been skeptical of the company’s use of variable rate loans, for now, it appears the company’s bet on lower interest rates has paid off.