In this weeks’ Sunday Spotlight, we piece together various indicators from bank earnings and industry calls as a read through to our Core Processor and IT Services coverage (FIS/WP, FISV/FDC ACN, CTSH, DXC, EPAM,). Earnings commentary suggests aggregate tech spend among large U.S. banks has maintained a healthy pace as enhancing digital offerings is critical to staying competitive and driving resilient deposit market share, with the ultimate goal of alleviating NIM pressure from the current low rate environment (see exhibits 1-6 below). We see this as a positive read for the Core Processors, which are optimally positioned to support large banks in the effort to enhance mobile banking, card processing, loyalty solutions, bill-pay, payments services, and others. For IT Services, while U.S. bank spend continues to exhibit healthy trends, pockets of weakness in Healthcare and Energy raise questions on aggregate investment trends, particularly in managed services.
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While fuel prices have been volatile, we suspect that 2Q will represent another sound quarter for WEX as Chevron/Shell continue to ramp, the strong enrollment season continues to materialize in numbers and its recent OTA win in Europe (Etraveli, ranks #10-15 globally) continues to roll on. Additionally, we look for continued progress with WEX Edge, its program offering customers discounts on non-fuel related spend, as well as its recent expansion of DriverDash availability to 13,000 Shell locations. While the company’s leverage ratio is such that a large scale M&A deal is unlikely in the near-term, we continue to see multiple drivers over the next several months, including: (1) Chevron/Shell portfolios rolling on, (2) pricing increases within the fleet segment, (3) GSA SmartPay wins (effective November 29, 2018), (4) Virtual card expansion, including its JCB partnership and Noventis acquisition and (5) DBI acquisition. With WEX currently trading at a 1x NTM P/E discount to its closest
We suspect that 2Q trends will mark a continuation of the strong 1Q result as the company continues to ramp its Mastercard portfolio, healthy trends across most non-Fuel segments continue and signs of traction across both Beyond Fuel and Beyond Tolls take hold. While we see some headwinds including (see Exhibit 2): 1) Chevron roll off continuing, 2) oil price volatility during the quarter (partially offset by spreads), and 3) freight volumes continue to worsen, we see total company organic growth being sound. Specific to the segments, we look for Beyond Fuel to continue to add 1-2pts of organic growth to Fuel, Corporate Payments’ strong sales cycle to enable sustained DD growth and Lodging’s digital bookings to partially offset the FEMA impact (added 4pts to segment growth in 2Q18). Additionally, with the company’s leverage sitting at ~2x, we see significant optionality for M&A.
While shares of BR were rangebound through 1Q19, the stock meaningfully outperformed in 2Q and is now up 38% YTD vs the S&P up 20%. Heading into F4Q investor focus remains on the FY20 guide and signs that demand for BR’s offerings remain intact. Bullish investors point to strong closed sales through F3Q of $161mm YTD (up 60% Y/Y and versus guidance of $185-225mm for FY19) and a growing recurring revenue backlog (>$300mm) as evidence FY20 earnings growth will be in-line or better than FY19. Recent management commentary suggests this backlog will convert in equal parts (a) within 4Q (b) in FY20 and (c) beyond FY20. From the bearish perspective, some have suggested that the Company’s hesitancy to update the long-term EPS guidance (9-13% EPS CAGR for FY17-FY20) as a sign FY20 may show an earnings deceleration (given ~22% CAGR through FY19E), while also pointing to softer revenue conversions in GTO.
Shares of ADS outperformed in today’s session (7/18/19) (up 5% vs S&P flat) following 2Q earnings, which were released pre-market. Expectations were relatively muted heading into results following a series of restructuring initiatives around its card portfolio and the sale of Epsilon (for proceeds that were below expectations). As such, relatively in-line results (excluding reserve timing and higher taxes), updated EPS guidance to incorporate buybacks and momentum in its shift towards a pure-play growing card business resonated with investors. In particular, credit remained stable and the company’s announced $900mm in planned portfolio acquisitions closed ahead of schedule (previously expected in 4Q). That said, the company also moved $500mm of incremental loans into HFS (claiming terms to renew were below ADS’ thresholds and thus allowing the file to move to a competitor).
IBM (covered by Andrew Vadheim, PP rated, $140 PT) reported 2Q earnings yesterday 07/17/19 with revenue strength relatively mixed across segments. Cloud and Cognitive Software accelerated Q/Q while the results in Global Business Services and Global Technology Services came in below expectations. That said, improved margin and a positive macro outlook for the remainder of 2019 drove share outperformance in today’s session (up 4% vs S&P flat). Given the magnitude of IBM’s reach across the enterprise client base for IT Services, we continue to see its results as an indicator for names in our coverage such as ACN, DXC, CTSH, and EPAM. For segment level CC performance see Exhibit 1 below.
Total revenues of $1,349mm (down 3% Y/Y), came in below the Street’s $1,352mm. Core EPS of $3.83 (down 12% Y/Y), came in below our $4.09 and the Street’s $3.94. Adjusted EBITDA, net was $310mm, below our $345mm and the Street’s $340mm. Despite the top and bottom miss, the company raised its 2019 EPS guidance to a range of $19.50-19.75, relative to $18.47 previously, supported by the planned $1.1B in repurchases from Epsilon proceeds and the recent decline in share price. Importantly, ADS closed on $900mm in portfolio acquisitions within the quarter, bringing ending receivables to $17.6B while also pressuring yields ~100bps and causing a reserve build (impacted card margins this quarter). For reference, management previously guided to these portfolios rolling on in early 4Q. Overall we see 2Q as relatively unsurprising and remain focused on the longer-term strategy to accelerate growth within card services and potential strategic actions around LoyaltyOne.
Overall, we view bookings and margin expansion as the two most important factors for driving future stock performance. Closing out FY19 we expect ADP to benefit from 1) a rebound in PEO growth off F3Q levels after a ~200bps State Unemployment Insurance (SUI) headwind, 2) stronger retention driven by the mid-market and easy comps, and 3) margin upside.
Heading into Visa and Mastercard’s earnings, we view JPM, C, and WFC 2Q bank card spending trends as solid with sequential acceleration across all three. That said expectations were for a seasonal pick-up as Easter and processing day timing positively impact results. We note that Citi and JPMorgan are the largest issuers for Mastercard and Visa respectively and act as decent read-throughs with regards to each networks’ payment volume and transaction trends. Importantly, our V/MA models already call for a slight acceleration of trends in calendar 2Q vs. C1Q rates of growth. We do apply some conservatism given the initial three-weeks of April trends had an outsized impact from Easter timing.
ADS reported its June credit data this morning with NCOs of 5. 8%, down 80bps Y/Y and down 50bps M/M (relative to the 5-year seasonal average of down 38bps M/M). For reference, the Company expects net charge offs to moderate below 6% in 2H19 and result in approximately 6% for the full year (in line with our model).
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