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Morningstar | FactSet's Outlook Will Be Tested as Markets Weigh on Clients

Wide-moat FactSet turned in a fiscal 2019 first quarter mostly within our expectations. The company grew GAAP revenue by 6.8% from the previous year while generating operating margins of 28.6%, an improvement of more than 150 basis points from the first quarter of fiscal year 2018. In addition, the company generated diluted earnings per share of $2.17. We’ll point out that FactSet achieved a significantly lower-than-forecast tax rate of 12.1%. Management is guiding to a higher tax rate close to 18% for the full year. Though a company’s tax rate can be volatile, had the company’s tax rate been closer to 18%, earnings per share could have been $0.14 lower, below consensus estimates. Unadjusted annual subscription value grew just 0.4% from the previous quarter. Though management gives a rosy view of its end markets, we do believe the recent market performance will result in a few layoffs at asset managers and will be a headwind for FactSet’s growth. Though we’re maintaining our forecast, in light of market performance, investors shouldn’t be surprised with downward revisions to estimates and our fair value estimates. That said, for now we’ll be maintaining our fair value estimate of $157 per share which suggests the company has more than 25% downside.

This quarter’s conference call didn’t inspire much confidence, either. During the preamble, the company mentioned cancelations in the quarter that appear to be related to FactSet’s strategic partnerships and alliances. Strategic partnerships and alliances is where FactSet sells data feeds or repackages its analytics in an unbundled format. Management has frequently discussed the importance of data feeds--we’ll remind investors that data feeds aren’t nearly as sticky a solution as traditional workstations. This quarter’s cancelations seem to support those concerns.

In addition, SG&A expenses grew 7% from the previous year, we thought it was interesting that management cited bad debt expense as one of the contributors. We think higher bad debt expense may be indicative of the health of FactSet’s end markets. We look forward to seeing FactSet’s 10-Q to see how much FactSet’s allowance for bad debt increased. We’ll point out the bad debt allowance as a percentage of receivables has been on an upward trajectory since the company acquired BISAM.

Finally, though cost of services decreased as a percentage of total revenue, FactSet mentioned higher variable data costs. We would expect this to continue as vendors of proprietary data are seemingly all pursuing growth through price increases. FactSet’s position as an intermediary between data and users puts the company in a difficult position. That’s largely why we don’t anticipate large sustainable increases in margins over the next five years.