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How this ASX stock is offering an underappreciated inflation hedge
Computershare (ASX:CPU) is a name synonymous with investing in Australia. Touted as “world leaders in financial administration” on its iwb website, the group is the dominant provider of share registry services in the country.
After floating on the ASX nearly three decades ago, in 1994, with a market capitalisation of just $36 million, the company has grown to over $12 billion and now has operations spanning nearly every continent.
Dubbed as one of Melbourne’s first start-up technology companies, Computershare began by providing simple computer bureau services, eventually expanding into registries, employee share plans, corporate actions and managing dividend payments. It may well be a modern-day success story in the fact that technology has evolved so much since 1994, but somehow the company has been able to continue to lead what remains an administration-driven industry.
CPU now manages 75 million customer records, employs 14,000 staff across the world and assists with the delivery of important documents and communications for a diverse range of shareholders. With a recent expansion into custody service, for which it holds assets on behalf of institutions, along with mortgage servicing and class action administration, the group has expanded into other “verticals,” which benefit from its experience. Despite many of these being lower-margin businesses, strong technology is capable of allowing reasonable profit margins to be extracted.
One of the most unique parts about the Computershare business may well be the most profitable and important parts of its future growth. It actually has many similarities to the many platforms that operate in the sector now, including Hub 24, Praemium and Netwealth. Computershare derives what is called margin income from the majority of its customers.
Margin income is similar to a bank, in that it represents the profit that the company is able to make while holding cash in its bank accounts on behalf of others. In the case of Computershare, this comes in the form of dividend payments, corporate actions and the like. The group is the central recipient and distributor of dividend payments on behalf of most of Australia’s largest companies. So, when a dividend is announced, the funds are paid to Computershare before being distributed to shareholders.
For instance, in the first half of the 2021-22 financial year, the group reported $1.1 billion in revenue from its “traditional” operations, 4.6 per cent growth and earnings of $217.8 million, of which $60 million came from this margin. Importantly, there is no cost associated with this revenue; it goes straight to the bottom line.
The challenge facing Computershare in recent years, though, has been the precipitous fall in interest rates that has made it extremely difficult to generate growth in this margin income. In fact, it fell as much as 40 per cent in 2021 after interest rates effectively moved to zero. The opportunity on the other side, however, is significant, with higher interest rates directly increasing the potential for higher margin income.
This is where the inflation hedge comes in, as inflation is typically associated with higher rates, which almost immediately convert to higher earnings. Assuming just a 25 basis point increase in US interest rates in the first half, the company expects see a significant jump in profit as a result.
Importantly, this is an ancillary benefit to a business that is otherwise generally doing quite well. In the first half of 2022 the company reported a 16 per cent jump in earnings, with growth in registry maintenance, governance and share plans offset by lower “event” (or “corporate”) action activity.
While defined as a technology company it is hard to squeeze the business into that sector. That said, CPU trades on a backward-looking PE ratio of around 17 times earnings and offers a yield of 2.4 per cent, with investors clearly pricing-in some hope for more margin income.
The broker community is generally positive on CPU, with four buys, two sells and a hold and the most optimistic price target of $27.
