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Morningstar | Cost Discipline Drives OFX’s Better-Than-Expected Underlying Fiscal 2019 Earnings; FVE Unchanged

A strong end to the financial year led to no-moat OFX Group earnings beating our expectations. Fiscal 2019 underlying net profit after tax or NPAT of AUD 21 million was about six percent higher than our forecast of AUD 19.8 million. Underlying NPAT was helped by disciplined cost control and a lower effective tax rate of 20% compared to our forecast of 24% and continuing guidance of 25%. Net operating income growth of 8% was particularly strong against the backdrop of a fall in global spot foreign exchange volumes throughout the year. While the results suggest the company is reducing its sensitivity to macroeconomic factors, global foreign exchange volumes remain an important earnings driver. On this point, management report that April 2019 was the lowest month for foreign exchange  volumes in the last five years, but volumes are picking slightly in May. These macro-economic headwinds prompt a slight reduction in our forecast for underlying NPAT in fiscal 2020 to AUD 21.8 million. The company also declared a final dividend of AUD 3.28 cents per share resulting in a full-year dividend of AUD 5.92 cents, slightly higher than our forecast dividend of AUD 5.7 cents. The 2019 dividends are fully franked but future dividends are expected to be franked at 70% because of the company’s lower effective tax rate from research and development investments and lower offshore taxes.

Our fair value estimate is unchanged at AUD 1.70 per share. As expected, the fundamental drivers of earnings were mixed. Higher transactions per active client and higher average transactions or ATVs per active client offset a 3.3% reduction in the number of active clients. These results reflect the company’s focus on its corporate business and recurring revenue. Revenue from corporate clients grew by over 10% in all regions. While harder to acquire, corporate clients transact more and have higher ATVs than consumer clients.

The company’s focus on corporate clients is the main driver of our forecast for transactions per active clients to increase from 6.7 in fiscal 2019 to 6.95 by fiscal 2024 and ATVs to rise from AUD 22,600 in fiscal 2019 to AUD 23,500 by fiscal 2024. The firm appears to be taking a disciplined approach to consumer clients, only targeting high-value consumers and this leads to a modest 2.7% CAGR forecast in active clients over the next five years. Some of the other key features of the result was continued strong revenue momentum in the growth regions of North America, with fee and trading income increasing by 19.8% in the U.S. and Canada, and up 19.3% in Asia, compared with 5.1% in Australia. Management plans to weight investments to North America and Asia, and we expect these regions to continue to be the main drivers of earnings growth.

We also think management will continue its cost discipline, with promotional expenses cut when it appeared too costly to acquire new customers in the face of lower foreign exchange volumes during fiscal 2019. This allowed the company to generate positive operating leverage at the EBITDA level. In turn, this saw underlying NPAT growth of about 12% in fiscal 2019. However, statutory NPAT was about 6% lower because of a non-recurring corporate action cost of about AUD 4 million relating to discontinued acquisition discussions with competitor Currency Direct. We think continued cost-cutting plans should result in trading revenue growth exceeding operating expenses growth by about 0.9% in fiscal 2020.

While the Currency Direct acquisition talks broke down, there is a distinct possibility that the company may grow inorganically by taking part in the likely consolidation in the foreign exchange payments industry. Management estimates that over the last five years there were about 7,000 new entrants in the foreign exchange payments market. Private equity firms drove much of this growth and are now looking to exit.

A further swing factor which may boost recurring earnings is the acquisition of a large enterprise customer. The company is building its pipeline of potential enterprise customers. Over the last few years, OFX has not acquired an enterprise customer of the size of current customers such as ING Bank or Macquarie Bank. Enterprise customers take much longer to acquire and require more senior sales staff to negotiate with senior management. Notably, the company expects an increase in employee costs in fiscal 2020 as it invests to reignite its enterprise business and continues to focus on its corporate segment. Enterprise customers are valuable if they are acquired at reasonable margins and capital expenditures as they generate recurring revenue with relatively low marginal costs, making them an efficient channel to acquire customers.