EUR 850.00 For Business Accounts Only

Morningstar | Market Continues to Award FactSet for Weaker Performance

Wide-moat FactSet Research Systems, modestly outperformed our expectations for the company’s fiscal fourth quarter. FactSet finished the fourth quarter with $347.1 million in organic revenue, representing year-over-year growth of 5.3%. The company has seen organic growth decelerate by 100 basis points over the last year. In addition, GAAP operating margins continue to contract. For fiscal 2017, GAAP operating margins were 27.1%, a 180-basis-point decline from 2017. This is the company’s worst margin performance going back at least 18 years. However, there are signs to be optimistic. During the quarter, the company won the right to provide Merrill Lynch advisors with market data. We estimate this deal will produce additional revenue somewhere in the neighborhood of $8 to $12 million annually and account for potentially 15% of FactSet’s fiscal 2019 growth. The company gave modestly better-than-expected guidance for 2019. As a result, we expect to increase our fair value estimate to $157 per share from $149. Nevertheless, we think the company is still significantly overvalued. Currently, the market values the company at nearly a 45% premium to our fair value estimate. In addition, the company trades at an EV/EBIT of 24.6 times. Our new fair value estimate would only translate into an EV/EBIT in the upper-teens.

Despite slowing growth, margin contraction, and headwinds from weaker buy-side customer demand, the market continues to award FactSet with a higher multiple. Not since the middle of 2001 has the company achieved such respect from the market. Owners of shares in FactSet will need to ignore the fact that in 2001 FactSet’s revenue grew by nearly 25% and diluted GAAP earnings per share grew by 28%. In comparison to this year, organic revenue expanded by 5.6% and diluted GAAP diluted earnings per share grew by only 4.1%.

For 2019, the company expects significantly improved profitability with operating margins expanding between 200 and 300 basis points to 29% to 30%. In addition, the company expects GAAP revenue growth of approximately 6%. Throughout the call, the company said these estimates were conservative. If we assume the Merrill Lynch deal is worth about $10 million in sales in 2019, then FactSet has to find growth of $70 million elsewhere. Unless the market hits a downturn, we think this number is likely within reach. However, we think improving margins will be a greater challenge. Based on management's guidance, total operating expenses will need to grow by approximately 4% or less. The company is facing headwinds from higher data and ongoing restructuring initiatives.

During the call, CEO Fred Snow mentioned integration of new acquisitions as a potential opportunity for greater savings. In addition, Snow said was looking to his new CTO to achieve greater efficiencies elsewhere. FactSet’s new CTO, Gene Fernandez, has been in the job in since November. Based on his Fernandez’s few public comments, we suspect he’d have the company explore public cloud infrastructure while automating quality assurance. We don’t doubt these strategies will help improve profitability, but we’d guess the company would have to temporarily increase investment in order to achieve sustainable gains in profitability. So far, we haven’t seen evidence of an increase in internal investment.