Fidessa Group (FDSA)


Stockwatch: A professional investors’ favourite

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Stockwatch: A professional investors’ favourite

Does this mark another inflection point of better times ahead for mid-cap financial trading systems stock Fidessa (FDSA)?

Latest 2016 prelims show a 25% advance in pre-tax profit to £48.8 million on revenue up 12% to £332 million, albeit 1% and 3% respectively at constant currencies. This materially beats expectations: e.g. by way of updating the table, profits beat the £44 million consensus expectation by 11% and you can see how this means 2017 forecasts likely need upgrading.

Recurring revenue being 87% of total revenue is supportive of the risk/reward profile. Diluted earnings per share is up 21%, and ordinary/special dividends by 11% reflecting a forward price/earnings (PE) multiple possibly in the low to mid-twenties and prospective yield near 4%.

To many observers Fidessa will look fully, if not over-priced, but so it has for many years with annual average historic PE's in the high twenties. Very strong cash flow means a strictly earnings-based view will always look over-valued, however - the stock's volatility possibly reflects an effort to guess between two valuation approaches.

At about 2,450p currently the near-term chart asserts a mini break-out from a recent downtrend to 2,200p amid Brexit uncertainties, the outlook statement citing "a reducing headwind" of closures/consolidations among clients and longer-term, "that we are entering a period where opportunity is returning to the market." This makes Fidessa interesting to follow.

A longstanding favourite among professional investors

With experience of Fidessa trading and investment management systems, various fund managers have built valuable long-term holdings, the largest being Lindsell Train's 15% stake worth nearly £145 million.

Normally, the sense of a focused position equates to high risk, but Lindsell Train manifestly has conviction, this is appropriate risk management in equities: "We aim to invest only in exceptional companies that have rare ability to grow the real value of their profits and cashflows over very long periods of time."

To private investors distanced from the technology however, Fidessa's revenue profile hardly flags a growth company, while its high PE and modest yield may help explain the stock's volatility, despite its rising overall from 1,500p in early 2013 to test 2,600p last August.

Yet see from the table how cash flow per share is over 2.5 times earnings per share. It's why Fidessa has not needed to issue shares in pursuit of development. So, with a modest 38.6 million shares issued, higher profits can easily boost earnings.

I have a couple of times overcome the classic reservations about Fidessa, to draw attention at 1,935p in October 2015 after the price had dropped from about 2,500p as low as 1,760p when interim results that August cited flat profits and earnings, albeit "a strengthening pipeline across the business" with market conditions improving.

Directors bought shares persistently around 1,880p through September and following their example has paid off. I reiterated a 'buy' stance at 2,370p in April 2016 as interest grew, and with Fidessa to benefit from the EU's "MiFID II" regulations (markets in financial instruments directive) given how, going back further years, Fidessa has seen revenue boosts in the order of 30% after regulation changes.

The price tested 2,600p in August then went into a volatile downtrend to 2,200p by last year-end, with the Brexit vote injecting uncertainty. Certainly, this and the US presidential election make it difficult to guess client demand for financial systems, although MiFID II is expected to be introduced as planned and to include the UK regardless of Brexit.

Meanwhile, the sell-side derivatives business should suffer less from client consolidations, which had the largest effect in the second half of 2016 and probably helped push the stock down.

US could present a significant opportunity

What's missing from the operations/outlook statement is any sense as to whether US financial deregulation could benefit a financial trading systems provider, as significant speculation in bank shares implies it could. Note 2 to the accounts - segment reporting - shows the US accounting for 43% of group revenue versus Europe (about 75% UK) at 36% and Asia, 21%.

Admittedly, it's early to say, and what effect is likely to be broad-brush, but considering also the likelihood of a strong dollar/weak sterling exchange rate persisting, it's an area to watch as a potential growth driver.

Fidessa's main US office will be relocated from New York to Jersey City "to position us with the footprint we need to further expand in this important market," albeit the costs will slightly reduce 2017 margin.

So, it's short-term unexciting, when also considering Fidessa sees 2017 overall revenue growth in constant currency around the same (i.e. 3%) levels seen in 2016, albeit further headline gains if sterling remains weak. The Americas grew 15% on a reported basis last year, or 2% at constant currency, and it currently seems hard to question US dollar strength as the Federal Reserve slowly shifts to interest rate rises.

Strong cash generation profile

Cash generated from operations rose 15% to £92.4 million, although it is trimmed to a 6.5% rise after the income tax bill jumped to £12.1 million. With significant investment undertaken, e.g. over £30 million product development, net cash generation before financing was £43.3 million, then dividends clipped this further to £12.2 million – helping end-2016 balance sheet cash rise 20.8% to £95.2 million. That ought to help support the "special" element of ongoing dividend policy. Unsurprisingly, there is no debt.

The range in brokers' share price targets likely reflects earnings versus cash flow valuation approaches, hence Barclays Capital's implied scepticism in targeting 1,860p and finnCap at 1,700p.

Numis, on the other hand, has been upgrading since last October with a 2,920p target and on 24 January advised 'buy' when raising its earnings and dividends forecasts. It will need to again. I should point out, Numis is one of Fidessa's brokers alongside Jefferies, although I cited Jeffries' 2,580p target back in October 2015, which was fulfilled by mid-2016. So, in one example, a corporate broker's insight has borne out.

Defining your objectives as an investor in Fidessa can, therefore, look sketchy, but on regulatory factors (higher in Europe, lower boosting financial institutions in the US) and currency considerations, it looks as if upgrades and underlying progress can this year take the stock above previous highs circa 2,600p.

Fidessa Group - financial summary               Forecasts
year ended 31 Dec     2012 2013 2014 2015 2016 2017
Turnover (£ million)     279 279 275 295    
IFRS3 pre-tax profit (£m)     42.0 43.1 39.1 39.1    
Normalised pre-tax profit (£m)     42.0 41.1 38.9 39.1 48.8 47.9
Operating margin (%)     15.0 14.6 14.0 13.1    
IFRS3 earnings/share (p)     80.9 83.5 75.8 76.5    
Normalised earnings/share (p)     80.2 76.8 74.4 76.4 92.3 92.8
Earnings per share growth (%)     1.3 -4.3 -3.1 2.7 20.7 -0.5
Price/earnings multiple (x)           32.1 26.5 26.4
Annual average historic P/E (x)       23.5 30.2 29.3 29.7 26.8
Cash flow/share (p)     182 183 189 199    
Capex/share (p)     95.1 104 103 115    
Total dividends per share (p)     82.0 82.0 83.1 83.5 92.5 88.7
Yield (%)             3.8 3.6
Covered by earnings (x)     1.0 1.0 0.9 0.9 1.0 1.1
Net tangible assets per share (p)     146 156 162 162    
Source: Company REFS                

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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