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Morningstar | FactSet Reliant on Muted Spending to Maintain Double-Digit Earnings Growth; Shares Overvalued

Wide-moat FactSet finished its second fiscal quarter mostly in line with our expectations, generating $2.19 per share in GAAP earnings and revenue of $354.8 million, representing year-over-year growth in sales of 5.9%. For fiscal 2019, we anticipate FactSet’s top line to grow by more than 6%. Year to date, the company is on track to meet our guidance. Despite mid-single-digit revenue growth, the company's operating income advanced by nearly 14% from the previous year. This is entirely attributable to management’s ability to hold the line on spending. Furthermore, the company’s operating expenses dropped almost 2% from the previous quarter driving operating margins 200 basis points higher to 30.6%. Management appeared to attribute much of this to currency, as well as ongoing efficiency initiatives. The company upped the low-end of its earnings guidance, but this appears partly attributable to favorable currency movements and a lower realized tax rate. We’ll be increasing our fair value estimate to $163 per share from $157, but this is only due to an increase in the time value of money and represents no change in our thesis. Currently, FactSet has an EV/EBIT of 21.7 times, we continue to believe FactSet is materially overvalued by the market.

We found FactSet’s comments around efficiency to be interesting. Specifically, management commented on locating operations centers in low-cost geographies as key to its cost initiatives. According to FactSet’s proxy statement, the company’s median employee makes $15,331 per year and this person works in Hyderabad, India. FactSet’s median employee is by far the cheapest in comparison to the company’s peers which have a median employee compensation of $55,857 which belongs to MSCI. We’ll point out that MSCI’s median employee is also located in an emerging market territory. The next closest cheapest employee to FactSet belongs to S&P Global with median employee compensation of $24,741. Given it appears FactSet has pushed outsourcing farther than any of its peers, we question whether the company can continue to realize greater expense efficiencies.

The bright spot of FactSet’s quarter probably came from the roll-out of its banking sector data which appeared to be drive some of its growth. The company’s ASV growth rate amongst sell-side clients accelerated to 9.2% during the quarter which is impressive considering the growth rate last year was only 4.6%. We’ll note this doesn’t include any revenues attributable to the Merrill Lynch deal which FactSet classifies as a buy-side client. Though it’s great to see that FactSet is winning business on the sell-side, it does appear growth is slowing amongst its buy-side clients. Given Merrill Lynch is considered a buy-side client and the buy-side accounts for 83.9% of FactSet’s clients, we have to wonder what growth in ASV would look like had FactSet not won this deal.