EUR 850.00 For Business Accounts Only

Morningstar | Seek’s 1H Result Slightly Better than We Expected. FVE Increased to AUD 19.00.

Narrow-moat Seek reported a slightly stronger first-half result than we expected, with revenue up 19% versus our previous full-year growth forecast of 16%. Management maintained full-year revenue growth guidance of 16% to 20%, versus our revised forecast of 21%, and EBITDA growth guidance of 5% to 8%, versus our 4.4% forecast. Management also increased their estimate of the cost of investments in early stage ventures in fiscal 2019 to between AUD 40 and AUD 45 million from AUD 35 to AUD 40 million. This means management now expects reported NPAT to be slightly below the prior year, rather than "broadly similar." However, these changes aren’t material to our valuation.

We have made several small adjustments to our earnings forecasts and increased our fair value estimate by 2% to AUD 19.00 per share. At the current market price of AUD 18.61, Seek remains fairly valued. The market price implies a fiscal 2019 P/E ratio of 34 and a dividend yield of 2.4%, or 3.4% including franking credits. These market price-based metrics are similar to those based on our fair value.

The main surprise in the result was the performance of Seek’s Chinese business Zhaopin, which comprises about 42% of group revenue and which generated local currency revenue growth of 39%. We previously assumed the division would achieve 22% revenue growth in fiscal 2019 but have increased this forecast to 40% following the strong first half. This strong growth rate reflects management’s strategic decision to reinvest profits to accelerate revenue growth, with the EBITDA margin falling to 18% from 22% in the previous corresponding period. This reduced the local currency EBITDA growth rate to 13% and our forecast has increased to 15% from 7%. It’s worth remembering Seek only owns 61%, meaning the contribution to Seek shareholders is less than the accounts imply.

The other notable aspect of Seek’s result was the continuation of weakness in the South American businesses. These include OCC in Mexico and Brasil Online in Brazil, comprising 4% and 2% of group revenue, respectively. We have cut our full-year forecasts accordingly but continue to expect improvement from fiscal 2020. Both businesses continue to struggle with a tough macroeconomic environment; however, aside from being small contributors to the group, both continue to have leading positions in their respective markets. From Seek’s perspective, these businesses provide diversification and extend its global footprint, an important strategic aspect of a software platform business.

Seek Asia, which comprises about 11% of group revenue excluding Zhaopin, performed well in the first half but broadly in line with our expectations. The division grew revenue by 11% in constant currency terms or 18% in Australian dollar terms. This is broadly in line with our full-year revenue growth rate of 13% in Australian dollar terms, which we have maintained. Unsurprisingly, strong revenue growth reflects organic user growth in Hong Kong, Singapore, Indonesia, and Thailand and growing penetration of depth products.

Seek has successfully diversified away from its highly profitable core Australian businesses, which comprised 29% of group revenue in the first half. Revenue growth of 13% was slightly lower than our previous 15% full-year forecast, which we’ve slightly reduced. Like other online classified advertising platforms in Australia, most of Seek’s revenue growth is coming from sales of "depth" products, or selling more appealing advertisements to existing clients, with muted growth from increasing volumes. The first-half EBITDA margin of 62% is relatively strong for the group but reflects the maturity of the business. We expect Seek’s other businesses to gradually increase margins, which underpins our group margin expansion forecast from 29% in fiscal 2019 to 36% over the next decade.

Management’s decision to reinvest in the business and sacrifice short-term profits for long-term growth has attracted investor criticism during the past year. For example, fiscal 2019 looks likely to be the third consecutive year of reasonably flat earnings growth, implying a statutory NPAT based EPS CAGR of negative 1% over the period. Considering the company trades on a relatively high multiple due to its growth attributes, this represents a dichotomy to some investors. However, we think revenue growth is a more relevant metric for Seek, and on this basis, the three-year CAGR is 18%. We are comfortable with management’s decision to prioritise revenue growth over profits in the short to medium term as the company operates in markets where network effects are the main source of competitive advantage, but usually only achieved by the leading provider. This means it’s important Seek achieves dominant positions in the relatively new markets in which it operates.

From a balance sheet perspective, Seek remains in good shape despite a 17% increase in net debt to AUD 1 billion during the half. On a look-through basis, net debt increased 15% to AUD 660 million. Nevertheless, we remain comfortable with credit metrics, including the net debt/EBITDA ratio of 2.3 and EBIT/net interest expense of 10 as at Dec. 31, 2018, and expect all metrics to gradually improve over the next five years.