Hub24: small cap structural growth idea
The ASX reporting season has been a very mixed bag, but the overall summation must be that it has been “disappointing”, particularly in terms of forward guidance.
The ASX200 has pulled back as a result of the disappointing earnings and guidance season, due mainly to analysts lowering forward earnings growth forecasts.
What that means to us is that genuine double-digit earnings growth for FY18 and beyond is getting harder to find in Australia and those stocks that offer it will continue to see their P/E multiples expand versus the broader “growthless” ASX200.
My fund, while global, picks stocks anywhere in the world where a top down structural growth theme meets excellent management execution and business model. That has led to the AIM Global High Conviction Fund delivering returns well ahead of the ASX200 and global equity indices.
The AIM Global High Conviction fund owns shares in and is increasingly confident about the outlook for Australian investment platform provider HUB24. We thought the HUB24 result was one of the clear highlights of the Australian reporting season.
Many of you have probably never heard of HUB24 (HUB.ASX) so I will start with a high-level description.
HUB allows investors to manage their portfolio of shares, term deposits, managed funds, model portfolios and other financial instruments through their advisor. The FY17 result highlights the scaleability of the business and potential for further margin expansion. They also delivered their first positive NPAT of $4.6m.
Financial advisors and planners are increasingly looking at migrating their funds to low-cost, more user friendly, non-institutional platforms. The easy-to-use interface has seen HUB receive several 1st place awards for overall client satisfaction and navigation. We see HUB having several points of differentiation, which include its mobile app, direct trading on international exchanges, reporting functionality and tax optimization tools.
Strong market share growth is highlighted by HUB taking 10% of the industry net flows through FY17, even with less than 1% of total market funds under management. A range of industry feedback indicates this is comes off the back of the market leading technology, functionality and overall platform satisfaction.
Source: HUB24 Annual Report Presentation (28 August 2017)
Wealth management is undergoing significant change and HUB is very well positioned to benefit from this tailwind. The changing landscape is driven by four key trends:
- Adoption of managed portfolios across dealer groups and advisers
- Market share shifting to non institutional platforms
- Convergence between advisory, stockbroking and financial advice
- Australians increasing use of international shares.
The March 2017 quarter highlighted the start of this shift, with the big 5 banks and AMP market share declining from 82.1% to 81.7%. Although at face value this seems small, 0.5% market share loss presents a significant opportunity for HUB and its smaller competitors. Netwealth, a competitor of HUB’s, is also able to take advantage of the changing industry space.
HUB’s advisor base has increased from 250 in FY14 to 1000 in FY17. HUB should also be able to take advantage of their advisors’ existing funds under management (FUM). HUB currently has an average of $6m per advisor, which compares to a total per advisor of $30-$40m.
Scaleability will help HUB expand margins and increase profitability as it grows. This operating leverage was clear in the FY17 result. Strong incremental EBITDA margin gains (52%) and segment margins are likely to continue improvement with additional FY18 investment. Key drivers of this margin expansion include add on products, increased trading activity, automation of administrative functions and having better negotiating power with third party service providers.
Source: HUB24 Annual Report Presentation (28 August 2017)
In January 2017, HUB acquired Agility Applications, a specialist technology services provider targeted at stockbrokers. The acquisition allows HUB to offer an integrated solution that allows brokers, advisors and accountants to reduce costs, increase efficiency and enhance client engagement. HUB has already started obtaining joint clients and this will be a key area for future development and investment.
HUB has given guidance for >$12bn funds under management over the next three years. This certainly seems within reach if FY17 growth continues to play out and the key tailwinds eventuate. Management highlighted that FY 2018 was already off to a good start through July and August, with $170m and $150m of inflows respectively.
We believe the culture of innovation in the company is clear. The international exchange capability, the Agility integration and incorporation of 3rd party apps (such as some forms of SMSF software) were all added in FY17 to stay ahead of competition. Such continued growth and innovation investments have street forecasts of +136% EPS growth in FY18, and 30-40% pa EPS growth over the next five years.
There seems to be a clear structural change in this space, and HUB is the best positioned to benefit from this, given their market leading technology offering. The end market is huge for HUB if they can continue to get their product right.
I love scaleable platform businesses in any industry, but particularly an industry such as Australian superannuation that is legislated to grow. Below is the consensus analysts revenue forecast for HUB for FY18. You can see it is in a structural upward revision cycle.
Source: Bloomberg Finance L.P. (30 August 2017)
I think HUB has all the hallmarks of a structural small cap growth stock. If it delivers to our expectations, I expect HUB to be an $8.00 stock in 12 months’ time. We have increased our investment in HUB since the excellent FY17 result.
If you consider an investment in HUB, I would remind you it is a small cap stock with limited liquidity. On that basis, it should be appropriately sized in portfolios.