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Technology Stocks

RingCentral Poised for Success as UCaaS Becomes the Business Communication Standard

Business Strategy and Outlook:

RingCentral is a leading unified communication as a service, or UCaaS, provider that enables omnichannel cloud-based business communication and collaboration on one platform, creating a single user experience. As an increasingly mobile workforce requires greater flexibility in business communications, we believe the firm’s offerings become more critical, and narrow-moat RingCentral should exhibit healthy long-term growth.

RingCentral’s core product, RingCentral Office, deploys a global unified communications platform that integrates messaging, video, phone, and other cloud-based communication solutions. Users are assigned a single business phone number and profile that allows for connection to the business network from any device and location. We view the platform’s 5,000-plus integration offerings as being particularly important in defining the value and competitiveness of the Office product. RingCentral’s moat is supported by strong user metrics, with net dollar retention rates above 100%, and most of its revenue is recurring in nature.

Financial Strength:

RingCentral is in a decent financial position. As of September 2021, RingCentral has $345 million in cash and cash equivalents versus $1.4 billion in debt. In March 2020 and September 2020, RingCentral issued $1.0 billion of convertible senior notes, due 2025 and convertible at $360 per share, and $650 million of convertible senior notes, due 2026 and convertible at $424 per share, respectively. In the second quarter of 2021, RingCentral redeemed the outstanding principle on its 2023 convertible senior notes. RingCentral has yet to achieve GAAP profitability, as it remains focused on reinvesting excess returns back into the company. RingCentral does not pay a dividend and has only repurchased stock sporadically. The firm has historically demonstrated decent cash flows, with free cash flow margins averaging 3% over the last five years, including a downward skew from 2020 where free cash flow was pressured as a result of the COVID-19 pandemic.

Bulls Say:

  • Partnerships with legacy PBX vendors give RingCentral access to a significant portion of the 450 million on-premises users, providing a powerful advantage over competitors in winning a large portion of the legacy install base. 
  • RingCentral is the first in its space to offer a CCaaS solution in addition to UCaaS, an offering we expect to prove influential in winning enterprise deals again. 
  • As an increasingly mobile workforce requires greater flexibility in business communications, RingCentral should face higher demand and have success increasing enterprise adoption.

Company Profile:

RingCentral is a unified communication as a service, or UCaaS, provider. RingCentral’s unified communications platform foremost replaces on-premises private branch exchange (PBX) phone systems, which support voice-only desktop phones, with its cloud phone system. Beyond its flagship voice product, the company’s platform enables cloud-based integrated omnichannel communications, including voice, messaging, SMS, video meetings, conferencing, and contact center software solutions, among others. The software allows businesses to communicate and collaborate all on one platform across various device-types.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Property

Volatility to accelerate in real estate market in 2022, but long-term outlook for Domain unchanged

Close up young business woman holding house model on hands with free copy space. Real estate loan banking concept. Building and construction.

Business Strategy and Outlook:

Domain offers exposure to favourable trends in the Australian real estate market, but with relatively low exposure to real estate price risk in the long term. The company has generated strong revenue growth in recent years, boosted by an increase in agents using its website, listings, premium listings, and acquisitions. However, we don’t expect similar growth from these factors in future, as we believe Domain now has near saturation of available agents and listings, and we don’t forecast further acquisitions

Domain can generate above-inflation growth in revenue per listing, as a result of above-inflation listing price growth and an increase in the proportion of premium listings on its website, from around 10% national penetration toward REA Group’s 20%. A revenue CAGR for the group of 12% over the next decade is expected. Domain benefits from a capital-light business model that should enable strong cash conversion and relatively low financial leverage. In addition, Domain has a business mix that includes print-related revenue, which is in structural decline, and which we suspect is a relatively low-margin business. Domain’s joint ventures with real estate agents also mean it will effectively achieve relatively low prices for its premium listings. Domain also has below-market-price service agreements with Fairfax that are likely to increase costs over the next few years.

Financial Strength:

Domain is in good financial health, which is in part due to the capital-light business model and expected cash flow strength. As with many software companies, most of Domain’s costs relate to employee costs, and the company does not require large capital expenditures to grow. The lack of capital requirements means cash conversion is usually high and cash flows are available for dividend payments and growth investments, such as acquisitions or investments in early-stage businesses. It also means that equity issuance is usually negligible, which means little or no dilution of existing shareholders. The coronavirus-related economic downturn will affect debt metrics in 2020, but Domain has negotiated a waiver of covenants to the end of the calendar year, by which time we expect the business to be recovering.

Bulls Say:

  • Domain is expected to generate high revenue growth, primarily owing to an increase in revenue per listing as a result of an increase in premium listings. 
  • Domain should benefit from Australian population growth of around 1%-2%, which should equate to a similar increase in dwelling numbers and therefore listings. 
  • Domain’s diversification into real estate-related businesses, such as mortgage, insurance, and utility services, is likely to strengthen the firm’s competitive position by increasing switching costs, and could diversify earnings.

Company Profile:

Domain is an Australian real estate services business that owns real estate listings websites and print magazines, and provides real estate-related services. Domain was formed as a home and lifestyle section of newspapers owned by Fairfax Media Limited (ASX:FXJ) in 1996, and an associated residential real estate website, www.domain.com.au, was launched in 1999. Domain’s real estate listings website has grown to become its core business and the second-largest residential real estate website in Australia, after REA Group’s (ASX:REA) owned www.realestate.com.au. Newscorp (ASX:NWS) owns 60% of REA Group.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Currencies Trading Ideas & Charts

AUD/USD: Sour sentiment directs sellers towards 0.7200 ahead of China GDP

The Aussie pair’s slump the previous day could be linked to the overall rally in the US dollar backed by the increased chatters over Fed rate hike, as well as the virus woes. It’s worth noting the market’s caution ahead of China’s key economic data.

The US dollar cheered the last dose of the Fed comments before the policymakers sealed the blackout period ahead of next week’s Federal Open Market Committee (FOMC) meeting.

Federal Reserve Bank of New York President John Williams said Fed is approaching a decision to begin raising interest rates.

Further, US Retail Sales for December printed -1.9% MoM figure versus 0.0% expected and +0.2% prior. Further, the Michigan Consumer Sentiment Index for January also eased to 68.8 versus 70 forecasts and 70.6 previous readouts. The details also suggest that the highest inflation in 40 years weighs on consumer behavior.

It should be noted that Australia’s most populous state New South Wales (NSW) reported the biggest daily covid-linked deaths on Friday with 29 deaths, recently easing to 17 cases. Even so, Australian health authorities are confident NSW will see a plateau in its COVID-19 hospitalizations next week, as the state’s numbers track “better than the best-case scenario” predicted.

Moving on, China’s headline economics will be crucial for the AUD/USD traders ahead of Thursday’s Australia jobs report. That said, China’s Q4 2021 GDP is expected to rise 1.1% QoQ versus 0.2% prior while the Retail Sales may ease to 3.7% versus 3.9% for December. Additionally, Industrial Production for the said month is likely to have softened to 3.6% versus 3.8% YoY.

(Source: FXStreet)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks

All Bulls for FactSet, Company Growing Strong

Businesswoman pointing at diagram in her hands when explaining marketing trends to her team during online meeting

Business Strategy and Outlook

Over the years, FactSet has built up an attractive subscription-based business providing data and analytics to the financial-services industry. FactSet is best known for its research solutions, which include its core desktop offering geared toward buy-side asset managers and sell-side investment bankers. Research makes up about 41% of the firm’s annual subscription value, or ASV, but is FactSet’s slowest growing segment due to its maturity and pressures on asset managers. Beyond research, FactSet offers analytics and trading solutions (35% of firm ASV), which include portfolio analytics, risk management, performance reporting, trade execution, and order management. 

FactSet’s fastest-growing segments are its data feed business, known as content and technology solutions, or CTS (13% of ASV), and its wealth management offerings (11% of ASV). Rather than through an interface, users of CTS access data through feeds or application programming interfaces, or APIs. Through repurposing its research and analytics capabilities, FactSet has built software products suitable for financial advisors. 

FactSet’s adjusted operating margins have been rangebound (31%-36%) over the last 10 years as it continues to invest in new content. It is believed this is prudent as investments have historically allowed FactSet to take share from competitors such as Thomson Reuters (now Refinitiv). In the future, it is anticipated some margin expansion as the company reduces its travel expenses and increases scale. FactSet has mostly grown organically and its acquisition strategy has mostly focused on adding an additional data source or software capability. In December 2021, FactSet announced it would acquire CUSIP Global Services from S&P Global for $1.9 billion, its largest acquisition to date. 

Given the consolidation in the financial technology industry, FactSet could become an acquisition target. The industry has seen large deals such as LSE Group acquiring Refinitiv and S&P Global acquiring IHS Markit. In addition, it is anticipated FactSet’s recurring revenue model would be attractive to potential acquirers, many of which have ample leverage capacity and valuable stock to use as currency.

Financial Strength

As of Aug. 31, 2021, FactSet has no net debt ($682 million in cash compared with $575 million in debt). Following the firm’s acquisition of CUSIP Global Services, it is projected FactSet to have a net debt to EBITDA ratio in the neighbourhood of 2 times. FactSet intends to maintain an investment-grade rating. Overall, it is seen, this increase in leverage as appropriate. Before COVID-19, FactSet has not been shy about share repurchases and returning cash to shareholders. FactSet slowed its share repurchases during the quarters ending May 31, 2020, and Aug. 31, 2020, but has since increased share repurchases. FactSet’s revenue is almost all recurring in nature and as a result it’s weathered the uncertainties of COVID-19 fairly well. FactSet’s client retention is typically over 90% as a percent of clients and 95% as a percent of ASV. FactSet also has low client concentration (largest client is less than 3% of revenue and the top 10 clients are less than 15%. In addition, compared with the financial crisis, FactSet has diversified its ASV from research desktops to analytics software, wealth management solutions, and data feeds. As a result, it would be comfortable with FactSet increasing its leverage for the right acquisition candidate. While revenue and margins may suffer in a downturn, it is poised that FactSet would still remain profitable.

Bulls Say’s

  • FactSet has done a good job of growing organic annual subscription value, or ASV, and incrementally gaining market share. 
  • FactSet’s data feeds business, known as content technology solutions, or CTS, and wealth management business represent a strong growth opportunity for the firm. 
  • There’s been a flurry of large deals in the financial technology industry and FactSet’s recurring revenue would make it an attractive acquisition candidate.

Company Profile 

FactSet provides financial data and portfolio analytics to the global investment community. The company aggregates data from third-party data suppliers, news sources, exchanges, brokerages, and contributors into its workstations. In addition, it provides essential portfolio analytics that companies use to monitor portfolios and address reporting requirements. Buy-side clients account for 84% of FactSet’s annual subscription value. In 2015, the company acquired Portware, a provider of trade execution software and in 2017 the company acquired BISAM, a risk management and performance measurement provider.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

PHILLIP NARROWING IT’S BUSINESS FOCUS, 50 FACTORIES TO LESS THAN 35 IN 5 YEARS

Business Strategy and Outlook

Philips is a one-stop shop for imaging-related devices with an established footprint in many hospitals, which positions it to benefit from long-term healthcare trends like the transition to nonor minimally invasive procedures, increased hospital demand for efficiencies or detection of sleep apnea. Through several divestitures and acquisitions Philips has transformed itself from an industrial-medical conglomerate into a healthcare company and primary supplier across hospitals, which facilitates the introduction of new products and the displacement of smaller suppliers with more depth in a single product line, but lack of breadth. In many of its underlying markets the company operates an oligopoly where significant market share is controlled by a few players. Several of the company’s products require proprietary software or service, which provide stability to cash flows and help to lock in the customer. In addition the company has carried out several divestments and acquisitions, which is supposed to have reinforced the company’s positioning. The company continues to narrow its business focus, with the sale of its domestic appliances business in 2021. 

It is alleged the company has room to improve its margins through improved operations management and cost efficiencies. Philips has made inroads on this front with a manufacturing footprint consolidation, where it has moved from 50 factories to less than 35 in five years. In D&T Philips has a large installed base built during many decades, which is suspected, has potential for improved service retention rates through remote monitoring, product sophistication and risk-sharing agreements. In connected care, Philips had a significant product recall on its sleep apnea installed base in 2021, which is assumed will result in a permanent loss of market share against Resmed. It is foreseen a long-term conversion pathway in toothbrushes from manual to electric, as a large percentage of the population still brushes manually. It is expected.6 the monitoring market will be a long-term beneficiary of COVID-19 due to hospitals realizing the need for efficiencies in patient management when hospital occupancy is high.

Financial Strength

As of September 2021, Philips had EUR 3.8 billion in net debt, which represented a 1.3 net debt/EBITDA ratio. Debt is denominated in euros and U.S. dollars, with an average interest rate of 2.0% and an average duration of around eight years. It is counter thought, Philips’ indebtedness level will be problematic given its relatively stable cash flow generation, and it is alleged, the company will have additional room for acquisitions, investments and dividends/buybacks. In the first quarter of 2021 Philips announced the sale of its domestic appliances business for EUR 4.4 billion. The proceeds will strengthen Philips’ balance sheet even more, giving the company more room to reinvest in the healthcare business, where it holds a stronger competitive position.

Bulls Say’s

  • Philips’ large installed base in imaging devices and existing footprint in many hospitals is an advantage that allows them to cross-sell and introduce new products with less effort than other smaller players.
  • Philips is a market leader in large unpenetrated markets such as sleep obstructive apnea and electric toothbrushes, where there are significant growth opportunities ahead.
  • The firm’s divestments are reducing the conglomerate perception Philips has among investors, which will provide more visibility on cash flows and future growth opportunities.

Company Profile 

Philips is a diversified global healthcare company operating in three segments: diagnosis and treatment, connected care, and personal health. About 48% of the company’s revenue comes from the diagnosis and treatment segment, which features imaging systems, ultrasound equipment, image-guided therapy solutions and healthcare informatics. The connected care segment (27% of revenue) encompasses monitoring and analytics systems for hospitals and sleep and respiratory care devices, whereas the personal health business (remainder of revenue) includes electric toothbrushes and men’s grooming and personal-care products. In 2020, Philips generated EUR 19.5 billion in sales and had 80,000 employees in over 100 countries.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Commodities Trading Ideas & Charts

IN CALIFORNIA BUDGET, NOTHING BUT GROWTH FOR  EDISON INTERNATIONAL

Business Strategy and Outlook

California will always present political, regulatory, and operating challenges for utilities like Edison International. But California’s aggressive clean energy goals also offer Edison more growth opportunities than most utilities. Policymakers know that meeting the state’s clean energy goals, notably a carbon emissions-free economy by 2045, will require financially healthy utilities. 

It is foreseen, Edison will invest at least $6 billion annually, resulting in 6% annual earnings growth at least through 2025. Edison has regulatory and policy support for most of these investments, but the timing of the investments could shift from year to year depending on regulatory delays, wildfire issues, and California energy policy changes. 

Growth opportunities at Southern California Edison address grid safety, renewable energy, electric vehicles, distributed generation, and energy storage. Wildfire safety investments alone could reach $4 billion during the next four years. 

It is alleged state policies will force regulators to support Edison’s investment plan and earnings growth. In August 2021, regulators approved nearly all of Edison’s 2021-23 investment plan. Regulatory proceedings in 2022 will address wildfire-specific investments and Edison’s $6 billion investment plan for 2024. 

Operating cost discipline will be critical to avoid large customer bill increases related to its investment plan. Edison faces regulatory scrutiny to prove its investments are producing customer benefits. It also must resolve the balance of what could end up being $7.5 billion of liabilities related to 2017-18 fires and mudslides. 

Large equity issuances in 2019 and 2020–in part to fund the company’s $2.4 billion contribution to the state wildfire insurance fund and a higher equity allowance for ratemaking–weighed on earnings the last two years. Edison now has most of its financing in place to execute its growth plan, and it is anticipated minimal new equity needs in the coming years. 

It is projected Edison to retain a small share of unregulated earnings, but those are more likely to come from low-risk customer-facing or energy management businesses wrapped into Edison Energy.

Financial Strength

Edison’s credit metrics are well within investment-grade range. California wildfire legislation and regulatory rulings in 2021 removed the overhang that threatened Edison’s investment-grade ratings in early 2019.Edison has kept its balance sheet strong with substantial equity issuances since 2019. It is not forestalled Edison will have any liquidity issues as it resolves 2017-18 fire and mudslide liabilities while funding its growth investments. Edison issued $2.4 billion of new equity in 2019 at prices in line with the fair value estimate. This financing supported both its growth investments and half of its $2.4 billion contribution to the California wildfire insurance fund. The new equity also allowed Southern California Edison to adjust its allowed capital structure to 52% equity from 48% equity for rate-making purposes, leading to higher revenue and partially offsetting the earnings dilution. Edison’s $800 million equity raise in May 2020 at $56 per share was well below the fair value estimate but was necessary to support its growth plan in 2020 and early 2021. In addition to Edison’s $1.25 billion preferred stock issuance in March 2021, it is projected it will need about $700 million of new equity in 2022-24 to support its investment plan. Edison will remain a regular new debt issuer but has few refinancing needs for the next few years. Beyond 2021, it is anticipated dividends to grow in line with SCE’s earnings. The board approved a $0.15 per share annualized increase, or 6%, for 2022, up from $0.10 per share annualized increases in 2020 and 2021. Management has long targeted a 45%-55% payout based on SCE’s earnings, but the board 

appears to be comfortable going above that range based on the 2021 and 2022 dividends that implied near-60% payout ratios. As long as Edison continues to receive regulatory support, it is alleged the board will keep the dividend at the high end of its target payout range.

Bulls Say’s

  • With Edison’s nearly $6 billion of planned annual investment during the next four years, it is  projected 6% average annual average earnings growth in 2022-25.
  • Edison has raised its dividend from $1.35 annualized in 2013 to $2.80 in 2022, an 8% annualized growth rate. Management now appears comfortable maintaining a payout ratio above its 45%-55% target.
  • California’s focus on renewable energy, energy storage, and distributed generation should bolster Edison’s investment opportunities in transmission and distribution upgrades for many years.

Company Profile 

Edison International is the parent company of Southern California Edison, an electric utility that supplies power to 5 million customers in a 50,000-square-mile area of Southern California, excluding Los Angeles. Edison Energy owns interests in nonutility businesses that deal in energy-related products and services. In 2014, Edison International sold its wholesale generation subsidiary Edison Mission Energy out of bankruptcy to NRG Energy.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Crown Draws Blood From a Blackstone

Business Strategy and Outlook

Morningstar analyst expect Crown Resorts to deliver strong earnings growth over the next decade, buoyed by the recovery from current coronavirus-induced lows as restrictions ease, the opening of Crown Sydney during calendar 2022 and continued solid performance from the core assets in Melbourne and Perth. Crown Melbourne and Crown Perth underpin the firm’s narrow economic moat. Crown is the sole operator in both jurisdictions, with long-dated licences. These properties have performed strongly, thanks to Crown’s solid track record of reinvestment, resulting in consistently high property quality, stable visitor growth, and earnings resilience. The quality of these assets, particularly Crown Melbourne, has driven strong growth in VIP gaming.

Indeed, the strong performance of Crown Melbourne helped the firm secure the second licence in Sydney to compete with The Star. As per Morningstar analyst view, the New South Wales government only issued the second licence because The Star’s performance significantly lagged Crown Melbourne in both revenue and EBITDA, depriving the state of taxation revenue. The Star Sydney’s EBITDA is roughly 60% of Crown Melbourne’s, despite Sydney being Australia’s largest city and the international gateway into Australia.

Morningstar analyst estimate Crown Sydney will not only take share from incumbent rival The Star, but will also grow the size of local casino gaming market–particularly in VIP. Morningstar analyst estimate VIP gaming will be a negligible share of revenue in fiscal 2022 amid border closures. However, it is expected that the segment to recover as border restrictions ease and tourism recovers. But VIP gaming can be highly volatile, ranging from over 30% of revenue in fiscal 2015 to 17% in fiscal 2017. Morningstar analysts estimate VIP gaming represents less than 20% of revenue at Crown Melbourne, less than 10% of revenue at Crown Perth, and will constitute more than half Crown Sydney’s sales-albeit at a lower margin than table gaming.

Crown Draws Blood From a Blackstone

Morningstar analyst have raised its fair value estimate for narrow-moat Crown by 8% to AUD 12.20 per share after directors supported an increased bid from narrow moat asset manager Blackstone. New York-based Blackstone, already Crown’s second largest shareholder with a stake of 10%, has been pursuing the beleaguered casino since March 2021 with prior bids unable to pique the interest of the Crown board. 

Crown had formally rejected Blackstone’s previous bid of AUD 12.35 and  the 1% improvement to AUD 12.50 would be unlikely to move the needle-particularly given regulatory uncertainty had eased with the Victorian Royal Commission stopping short of cancelling Crown Melbourne’s licence, instead providing Crown a roadmap to redemption. The AUD 13.10 offer is more compelling, representing a 16% premium to our standalone fair value estimate and a 32% premium to the undisturbed price on Nov. 18, 2021. Crown’s board flagged its unanimous intention to recommend shareholders vote in favour of the proposal, should a formal bid eventuate.

The increased offer is nonbinding and remains conditional on completion of due diligence, support from shareholders, unanimous approval from the board, final approval from Blackstone’s investment committees, and approvals from state gaming regulators. While Blackstone is prepared to proceed while Crown’s various regulatory investigations and consultations remain underway, negative outcomes arising in the meantime (such as the loss or suspension of a casino licence) could thwart the bid.

For the transaction to proceed, support from 37% shareholder Consolidated Press Holdings, or CPH, will be crucial. Via CPH, former executive chair James Packer’s major shareholding remains a headache for regulators. But the Blackstone deal could be seen as taking risk off the table for regulators, given the scrutiny on the relationship between Crown and CPH/James Packer since the commencement of the Bergin casino inquiry. Indeed, the Victorian commissioner’s report has since recommended CPH have until September 2024 to sell down its holding to less than 5%. 

Financial Strength

Despite near-term earnings weakness, Crown’s balance sheet remains robust. Debt levels have increased with the construction of the Crown Sydney casino and forced venue closures due to COVID-19. Crown’s net debt/EBITDA peaked at 3.7 in fiscal 2021, from 1.8 as at the end of June 2020, but still below the precarious 5.0 level (the covenant limit on Crown’s subordinated notes). We expect significant deleverage in fiscal 2022, aided by around AUD 450 million in further apartment sales from the Crown Sydney project and earnings recovery. We forecast fiscal 2022 net debt/EBITDA to fall to 0.5, and with an improved balance sheet, expect the firm to reinstate dividends from the second half of fiscal 2022 at around 75% of underlying earnings

Bulls Says

  • Long-dated licences to operate the only casino in Melbourne and Perth allow Crown to enjoy positive economic profitability in a regulated environment. 
  • Crown Sydney provides a long-term growth opportunity to capture share and expand gaming in Australia’s most populous market. 
  • Crown is well positioned to benefit from the emerging middle and upper class in China.

Company Profile

Crown Resorts is Australia’s largest hotel-casino company. Its flagship property is Crown Melbourne, an integrated complex with more than 2,600 electronic game machines, or EGMs, 540 tables, and three hotels. Crown also operates Crown Perth, a property with more than 2,500 EGMs, 350 tables, and three hotels. Crown has also obtained a licence to operate Sydney’s second casino, Crown Sydney, centred on the VIP and premium gaming market. The company also operates Aspinall’s, a boutique, premium-focussed casino in London.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

Wipro’s Q3 Aided by Inorganic Growth, but EPS Falls Short; Maintaining INR 495 FVE

Business Strategy and Outlook

Wipro is a leading global IT services provider with the typical menu of offerings, from software implementation to digital transformation consulting to servicing entire business operations teams. Wipro benefits from switching costs and intangible assets, although Morningstar analyst also see it benefiting from a cost advantage. Forays into the higher-value realm of industrial engineering will help ensure that Wipro does not miss out on substantial growth trends in the overall IT services industry.

In many regards, there’s uncanny resemblance between Wipro and its Indian IT services competitors, Infosys and TCS, such as in its offerings, offshore leverage mix (near 75%), or attrition rates (near 15%). However, Wipro has pockets of solutions where it distinguishes itself. 

Wipro isn’t unusual for being an IT services provider with switching costs and intangible assets. These are founded on the intense disruption that customers would experience when changing their IT services provider as well as Wipro’s specialized knowledge of the industry verticals it caters to and the distinct knowledge of its customers’ web of IT piping. But besides these two moat sources, Morningstar analyst think Wipro benefits more from a cost advantage (which we only allot to Indian IT services companies) based on its labor arbitrage model. Morningstar analyst also thinks that benefits from such a cost advantage will diminish over time as the gap between Indian wage growth and GDP growth in primary markets narrows, analyst view that Wipro’s moat is secure as the company’s foray into higher-value offerings and increasingly automated solutions offsets this trend.

Wipro’s Q3 Aided by Inorganic Growth, but EPS Falls Short; Maintaining INR 495 FVE

Wipro gave guidance of 2%-4% sequential revenue growth in its IT services segment for the quarter ahead. All in all, Morningstar analyst maintaining  INR 495 fair value estimate for Wipro and  believe Wipro is overvalued even with shares down 8% upon results–much like other Indian IT services giants Tata Consultancy Services and Infosys.

Third-quarter revenue grew 30% year over year to INR 203 billion due to year-over-year growth in all seven of its sectors led by 50% year-over-year revenue growth in its largest sector, banking, financial services, and insurance, indicating continued strong results from its previous Capco acquisition. Wipro continues to see a large portion of revenue growth stemming from inorganic acquisitions completed earlier in 2021. . Still, IFRS EPS came in at INR 5.42 which missed our expectations of INR 5.64 due to salary increases and additional headcount.

Financial Strength 

Wipro’s financial health is in good shape. Wipro had INR 350 billion in cash and cash equivalents as of March 2021 with debt totalling INR 83 billion. Morningstar analyst expect that Wipro’s cash cushion will remain healthy, as it is expected that free cash flow to grow to INR 118 billion by fiscal 2026. This should allow for continued share buybacks and acquisitions. Morningstar analyst expect that share buybacks over the next five years will average INR 50 billion each year and forecast that acquisitions over the next four years following fiscal 2022 will average INR 9 billion each year. While analyst don’t explicitly forecast dividend increases over the near term, and think Wipro will have more than enough of a cash cushion to undergo any dividend raises as desired without needing to take on debt.

Bulls Say

  • Wipro could benefit from greater margin expansion than expected in our base case as more automated tech solutions decrease the variable costs associated with each incremental sale.
  • Wipro should profit from a wave of demand for more flexible IT infrastructures following the COVID-19 pandemic, as more companies seek to be prepared for similar events. 
  • As European firms become more comfortable with outsourcing their IT workloads offshore, Wipro should expand its market share in the growing geography

Company Profile

Wipro is a leading global IT services provider, with 175,000 employees. Based in Bengaluru, the Indian IT services firm leverages its offshore outsourcing model to derive over half of its revenue (57%) from North America. The company offers traditional IT services offerings: consulting, managed services, and cloud infrastructure services as well as business process outsourcing as a service.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Dividend Stocks Expert Insights

Ferguson’s coverage to the RMI market enhanced from 31% to 60%

Business Strategy and Outlook

In the United States, Ferguson primarily serves three major end markets: repair, maintenance, and improvement, new construction, and civil infrastructure. Between 2008 and 2020, Ferguson’s exposure to the RMI market increased from 31% to 60%, while new construction decreased from 58% to 32%. Increased exposure to the U.S. RMI market will benefit the company because elevated demand for repair and remodel services due in part to aging housing stock. While the repair and remodel market are less cyclical than new construction, it still tracks housing construction activity. It is projected total housing starts to average approximately 1.6 million units annually this decade, which is above the historical long-run average. 

Ferguson has built leading positions in many different end markets through its roll-up acquisition strategy. The company typically acquires local competitors, gaining access to new brands, suppliers, regions, and customers. Ferguson is projected to continue this strategy, which should augment its scale-driven competitive advantage. Ferguson’s pricing strategy has transformed from being primarily localized to more standardized across the group over the past decade. In the past, branch managers had more discretion over pricing to react to local competitive dynamics. Today, the company employs a more disciplined approach to pricing, allowing it to take better advantage of its economies of scale. 

Ferguson sold its Wolseley U.K. business for approximately $420 million in February 2021. This business struggled to generate value for the group despite being one of the largest distributors in the United Kingdom. There were very few synergies between geographies and little overlap in suppliers. Ferguson’s strategic shift to the United States will be a tailwind for the firm’s prospects, and the listing on the New York Stock Exchange (shares began trading in March 2021) could increase interest from U.S. investors. Shareholders will vote on a U.S. primary listing in spring 2022.

Financial Strength

Ferguson set out to clean up its balance sheet following the great financial crisis, and it improved net debt/EBITDA from 3.5 times before the 2008 crisis to 0.6 times as of Oct. 31, 2021. Net debt at the end of the first quarter of fiscal 2022 (October 2021) was $1.4 billion. Ferguson’s strong balance sheet gives management the financial flexibility to run a balanced capital allocation strategy that augments growth with acquisitions but also returns cash to shareholders. In terms of liquidity, the company can meet its near-term debt obligations, given its strong cash balance. Its cash position at the end of the first quarter of fiscal 2022 stood at $2.2 billion. Ferguson’s ability to tap available lines of credit to meet any short-term needs is making the scenario comforting. The countercyclical nature of industrial distributors’ free cash flow generation, which results from the ability to drawdown inventory during times of economic malaise is also encouraging. Ferguson generated over $1 billion of free cash flow during the great financial crisis, and we expect current economic weakness to push free cash flow levels materially higher as working capital requirements ease. In our view, Ferguson enjoys a strong financial position supported by a clean balance sheet and strong free cash flow prospects.

Bulls Say’s

  • Ferguson’s roll-up strategy in the U.S. should lead to market share gains, boosting revenue growth more than the market average. 
  • Ferguson’s strategic shift to the U.S. away from international markets has strengthened group operating margins. 
  • Ferguson generates strong free cash flow throughout the economic cycle despite serving cyclical end markets

Company Profile 

Ferguson distributes plumbing and HVAC products primarily to repair, maintenance, and improvement, new construction, and civil infrastructure markets. It serves over 1 million customers and sources products from 34,000 suppliers. Ferguson engages customers through approximately 1,600 North American branches, over the phone, online, and in residential showrooms. In fiscal 2021, Ferguson derived 94% of its nearly $23 billion of sales in the U.S. According to Modern Distribution Management, Ferguson is the largest industrial and construction distributor in North America. The firm sold its U.K. business in 2021 and is now solely focused on the North American Market.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

Fastenal Co.: To fund a shareholder-friendly capital allocation strategy

Business Strategy and Outlook

Since opening its first fasteners store in 1967, Fastenal has built one of the largest industrial distribution businesses in the United States. For many years, Fastenal’s growth story was driven by its branch count, which now stands at approximately 1,900. While this expansive footprint is still an important component of Fastenal’s business model, other strategies–including expanding its product portfolio, its vending and inventory management services, and most recently, its on-site program–have become increasingly important growth drivers. 

The benefits of Fastenal’s vending, inventory management, and on-site services are twofold: Not only do these services drive incremental revenue, but they also embed Fastenal in its customers’ procurement processes, which supports higher retention rates and pricing power. Fastenal has a first-mover advantage in both vending and on-site services, introducing the former in 2008 and the latter in 1992 (although the on-site strategy did not become a focused strategy until the past few years), and we see long growth runways for both offerings. In addition to growth through its vending and on-site initiatives, Fastenal is well positioned to benefit from customer consolidation trends. In recent years, customers have been consolidating their maintenance, repair, and operations, or MRO, spending with large distributors to leverage their purchasing power and increase operational efficiency. With its national scale, broad product portfolio, and inventory management services, Fastenal can capitalize on this trend and take market share from smaller and less capable distributors. 

Because Fastenal’s sales mix is increasingly skewing more toward large national accounts, on-site programs, and more price-competitive MRO products, the company’s gross margins are likely to come under pressure. However, the combination of higher sales volume and containment of selling, general, and administrative costs provide Fastenal the opportunity to realize strong operating leverage and expand operating margins. It is forecasted Fastenal’s operating margin to reach 21% by our midcycle year.

Financial Strength

Fastenal has an outstanding debt balance of approximately $405 million. It is leveraged at only 0.3 times 2021 EBITDA, which is very conservative relative to the other industrial distributors. Fastenal’s earnings provide substantial headroom to service debt obligations. During fiscal 2020, Fastenal incurred only about $10 million of interest expense and generated about $1.3 billion of EBITDA, which equates to an extremely comfortable interest coverage ratio. Even with its expansive store footprint and cyclical end markets, Fastenal has a proven ability to generate free cash flow (defined as operating cash flow less capital expenditures) throughout the cycle. Indeed, it has generated positive free cash flow every year since 2003. Given its conservative balance sheet and consistent free cash flow generation, we believe Fastenal’s financial health is satisfactory.

Bulls Say’s

  • Vending and on-site programs should provide a long growth runway for Fastenal. 
  • Fastenal can capitalize on its national scale, broad product portfolio, and inventory-management services to take market share from smaller and less capable distributors. 
  • Despite serving cyclical end markets, Fastenal’s business model generates strong free cash flow throughout the cycle. Fastenal is likely to continue to use its cash flow to fund a shareholder-friendly capital allocation strategy.

Company Profile 

Fastenal opened its first fastener store in 1967 in Winona, Minnesota. Since then, Fastenal has greatly expanded its footprint as well as its products and services. Today, Fastenal serves its 400,000 active customers through approximately 1,900 branches, over 1,300 on-site locations, and 14 distribution centers. Since 1993, the company has added other product categories, but fasteners remain its largest category at about 30%-35% of sales. Fastenal also offers customers supply-chain solutions, such as vending and vendor-managed inventory.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.