TC's call: "Outperform" with no price target.
The major drivers of PSI’s 17% EBITDA growth during FY19 included:
Organically, Group EBITDA grew by ~7.5% (excl. investment income and currency benefits), entirely distribution driven – well below the previous 3year average of ~20%. More specifically we observed organic EBITDA change of +18%, -10% and +4% during FY19 respectively across Distribution, Agency and UK. In Distribution, strong client growth, modest premium rate rises and optimisation of the cost base across owned brokers, offset flat earnings from the network business. The latter a consequence of planned strategic spending to support future growth prospects.
A tightening of underwriting terms and remuneration paid to Agencies impacted profitability on the renewal book. Heavily 2H weighted, we are not anticipating material headwinds during FY20. Importantly, binders that remain in place are not constrained, and the Group is not expecting further altering of underwriter terms. This serves as a reminder that the earnings quality from Agencies pales in comparison to traditional broking businesses. Our FY20e imply that Agencies will generate ~10-12% of PSI’s EBITDA.
Rebalancing the UK business was the main driver of subdued performance. Namely restructuring Alsford Page & Gems as it abandons its’ African originated book, and to a lesser extent, redistribution of workflows from within to outside of the Group. Looking further ahead, we forecast improved earnings momentum from this region as Chase International builds scale and starts to win more material contracts, while Paragon (an expected settlement of 2Q19) continues to take market share and perform ahead of acquisition metrics.
Earnings Revisions. We have adjusted our FY20e EBITDA from $60m to $58.1m to reflect a later than anticipated settlement on Paragon. Combined with now forecast higher interest costs we have downgraded our FY20/FY21e NPATA by 5.2% and 2.6% respectively.
Valuation & Recommendation
Net of listed investments, PSI trades at 19.8x our FY20e EPSA (on a fully diluted basis) - growing at 24.5% EPSA (0.80x PEG). Our FY21e EPSA growth of 14.1% only accounts for announced acquisitions. It is possible that additional acquisitions could lead to upward revisions to our FY21e EPSA growth assumptions of closer to 17-20%. See page 3 for our assumptions in EBITDA growth. Combined with 3.6% div. yield, highly aligned management team who have proven to be prudent allocators of capital, we continue to believe shareholders will be rewarded in the medium term. Future acquisitions should improve stock liquidity. As this occurs, PSI’s valuation discount on an EPSA basis of approx. 10-12% to global peers could close. We maintain our Outperform recommendation.
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