EUR 850.00 For Business Accounts Only

Morningstar | Seek FVE Cut 4% on Higher Cost Outlook

We have cut our fair value estimate for narrow-moat-rated Seek by 4% to AUD 18.00 per share following higher-than-expected cost guidance and a reduction in our profit forecasts. At the current market price of AUD 20.02, we still believe the shares are overvalued. The 9% share price fall that followed the announcement most likely reflects investor concerns about the increasing short-term discrepancy between statutory and underlying profits, along with management’s ability to generate attractive returns on its investments.

We have cut our fiscal 2018 reported net profit after tax forecast by 72% to AUD 59 million, which largely reflects the impact of the impairments to the South American businesses. This represents an 83% fall versus the fiscal 2017 result, which was boosted by an AUD 161 million one-off gain. On an underlying basis, we have cut our fiscal 2018 NPAT forecast by 3% to AUD 214 million, implying an 11% increase on fiscal 2017; however, this growth includes the boost from a change in accounting policy for the Online Educational Services business, without which the growth is 5%. Based on our revised forecasts, the market price implies a fiscal 2019 price/underlying earnings ratio of 32, versus 29 at our fair value estimate.

We aren’t too concerned about the AUD 178 million in noncash impairments relating to Seek’s South American businesses, which include Brazil Online and OCC in Mexico. Both businesses have been struggling with challenging macroeconomic conditions for some time, but we don’t believe either faces structural challenges, and we expect both to recover eventually. Combined, these businesses only contribute around 7% of group EBITDA, meaning they aren’t key earnings drivers for the group and their book value has a high degree of subjectivity.

We expect investors are concerned about the declining trend in profit margins. Seek reported an EBITDA margin of 47% in fiscal 2009, but this margin has gradually fallen over the past decade, and we now forecast margins of 32% in fiscal 2018 and 29% in fiscal 2019. Admittedly, the complexity of the group's corporate structure and the high-growth nature of the portfolio of businesses mean these comparisons may not necessarily be fair, but they’re notable nevertheless.

Management’s preference is to exclude around AUD 30 million in early-stage venture, or ESV, losses from fiscal 2018 and 2019 EBITDA margins, which paints a different picture. However, it’s almost impossible to verify the extent to which these supposedly temporary losses are actually ongoing costs. At this stage, we include ESV losses in our underlying profit forecast and assume they will become profits by fiscal 2021, with our view influenced by Seek’s good track record of investments within the employment sector. There’s also logic in high-growth technology businesses like Seek sacrificing profits for revenue growth, as they often operate in "winner takes all" markets. Seek is competing fiercely for a leading position in the Chinese online employment market, and we believe the increased investment makes sense.

Investor concerns are likely to be compounded by the recent reorganisation of the company into two main divisions: Asia Pacific and Americas, or AP&A, and investments. Although the restructure, which is now four months old, is unlikely to deliver material cost savings, management claims that it’s already delivering operational benefits. However, the potential for reduced disclosure at a time of guidance downgrade is likely to concern investors in the short term.