EUR 850.00 For Business Accounts Only

Morningstar | OFX Group’s Earnings Downgrade Prompts a Moderate FVE Reduction

We have cut our fiscal 2019 EBITDA forecast for no-moat-rated OFX Group by 5% to AUD 31.8 million following management’s lowered guidance of AUD 30.9 million to AUD 32.0 million. Our lower fiscal 2019 forecast causes a reduction in later year forecasts and has reduced our fair value estimate by 6% to AUD 1.70 per share. However, at the current market price of AUD 1.65, the stock remains fairly valued.

The downgrade was mainly caused by lower than expected foreign exchange rate volatility, and global spot transaction volumes leading to lower active clients in the second half of fiscal 2019. The company is sensitive to lower exchange rate volatility which are caused by macroeconomic factors outside of the company’s control and is reflected in our high fair value uncertainty rating.

We expect lower active client growth to persist, although partly offset by higher average transaction values or ATV due to the company’s focus on its corporate segment. OFX indicates active clients have not grown as much as anticipated, although corporate revenue was up more than 10%. We expect active clients to grow by a CAGR of 2.2% over the next five years, compared with 4.3% over the past five years. However, the focus on its corporate segment should see an increase in ATVs. OFX’s corporate customers’ ATV was AUD 24,900 in fiscal 2018, which compares favourably with its consumer customers’ ATV of AUD 16,700. We estimate the company’s focus on growing its corporate segment should lead to group ATV increasing from a low of AUD 22,000 in fiscal 2018 to AUD 23,500 in fiscal 2023.

We believe two of the main swing factors to the company’s fundamental value is the potential for it to achieve nonorganic growth and scale by participating in the ongoing consolidation occurring in the foreign exchange payments market and/or by reigniting its enterprise segment. The company estimates that over the last five years there were about 7000 new entrants in the foreign exchange payments market, and the private equity firms that drove much of this accelerated growth are now looking to exit their investments. Notably, it recently attempted to capitalise on this phenomenon by entering negotiations to acquire UK-based competitor Currency Direct from its private equity firm backer. While these negotiations did not amount to anything and will cost the company non-recurring costs of AUD 4 million (not included in our underlying NPAT) the fragmented nature of the market provides for other opportunities.

We also expect the company to attempt to reignite its more recently stagnant enterprise business. Management indicate that there is a pipeline of potential enterprise customers that its targeting. In recent years, the company has not acquired an enterprise customer of the size of current customers ING Bank or Macquarie Bank, to whom it provides white-label foreign exchange payment services. Enterprise customers take a much longer lead-time to acquire and require more senior staff who can negotiate with the enterprise customer’s senior management. They also may require higher capital expenditures to integrate OFX’s systems into the enterprise business’s systems. Nevertheless, they have the potential to generate material value for the company if they are acquired at reasonable margins and capital expenditures investment. This is due to their ability to generate recurring revenue with relatively low marginal costs. Additionally, the revenue generated by enterprise customers is more sustainable, as it’s not as sensitive to macroeconomic factors such as low foreign exchange rate volatility.

We also expect the company to grow its United States business. This business continues to perform strongly, with impressive growth in both its consumer and corporate segments. The U.S. foreign exchange payments market continues to be dominated by the major banks who continue to charge higher fees and provide poor consumer service. This creates an opportunity for OFX Group to win market share, like it’s done in Australia. We expect it should also benefit from major competitor World First exiting this market about a month ago. Major Chinese firm Ant Financial is proposing to acquire World First (an example of the consolidation occurring in the foreign exchange payments market), and World First appears to be attempting to avoid U.S. regulators from scuttling this proposed deal by abruptly ceasing operations in the U.S.. This leaves World First clients stranded, who OFX management indicate they are already in the process of contacting.