Today Netwealth (NWL) delivered a first-half underlying profit of $20.6m, which was 2% ahead of market expectations and 20% higher than last year.
Importantly, Netwealth grew its platform revenue base by 21%. Expenses also expanded but overall the group demonstrated a more than satisfactory EBITDA margin of 52%. NWL also declared an interim fully franked dividend per share of 6.9¢; up 25% on last year.
Over the past 6 months, market participants have been fretful that lower official cash rates would dramatically impact NWL’s income earning potential; as cash rates converged to zero the expectation was that platforms would essentially lose their ability to offer the RBA cash rate less 0.5% on client’s cash balances.
This notion led to a large increase in short positions which stands at 11m shares, meaning that 12% of the free float is currently sold short. We appreciate the arithmetic of zero-bound interest rates however we believe that customers will increasingly reduce cash balances and redeploy capital towards more prospective investment options within the NWL platform.
Netwealth to grow into its high PE
On a valuation basis, NWL has always looked expensive relative to other financial companies. Since listing in 2017 NWL has traded on an average PE of 45x next year’s profit compared to the ASX Financial sector on 17x. In addition, NWL has offered a dividend yield of just 1.6% which has typically been 5% below the financial sector.
These valuation multiples have caused many market participants to avoid investing in NWL. However, we believe that NWL will quickly grow into its valuation metrics.
Firstly, NWL carries no debt and has more than $73m in cash reserves. We believe that this cash can work harder and could, in fact, supplement earning per share by 3-4%pa; cash could be invested in a higher returning asset class or surplus capital can be retired.
Secondly, NWL is a capital light business; the group has consistently generated a return on equity above 50% and hence very little capital is wasted pursuing unproductive investment opportunities. Accordingly, NWL generates considerable free cash flow.
Although NWL offers a meagre dividend yield of 2%, this yield is fully franked so the grossed-up yield is more like 2.8%. In a 1% term deposit world, this dividend yield is relatively attractive. But more importantly, we believe that NWL can grow its dividend by at least 10%pa for the next 5 years.
Netwealth could more than triple its market share
NWL provides investment solutions within the Australian platform market. The platform market has been growing nearly 10%pa over the past decade and is now approaching $1 trillion. The growth has been fuelled by rising asset prices and compulsory superannuation contributions.
The platform market is dominated by the 4 major banks and AMP who collectively have a 68% market share.
NWL has just a 2.9% share but has been consistently leading the market in net funds flow and has subsequently grown 3 times faster than the underlying market.
Unlike the major players, NWL is solely focused on enhancing their customers investing experience. NWL’s main competitors are extremely distracted by numerous exogenous influences and are unsurprisingly losing meaningful amounts of platform market share.
NWL has the added benefit of being nimble enough to adapt quickly to technological advancements or regulatory imposts. We feel that NWL has the potential to command a 10% share of the platform market by 2025 without sacrificing too much margin, more than tripling its share of the domestic market.
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Where do you place NWL amongst competitors like HUB24 and Praemium?
Andrew, I don’t really view Hub24 and Praemium as the competition. They are specialist service providers that control less than 2% of the market. I feel that all of the specialist providers are competing vigorously with the 5 main incumbents who have amassed 68% of the market. We believe that of the specialist providers NWL has the experience, balance sheet, focus and flexibility to consistently deliver a service that customers deserve and value. As a result we believe that NWL is best placed to compete effectively with the 5 majors for many years to come. Regards David
Do you own the stock?
Jonathan, NWL is held in the K2 Small Cap Fund (ASX code KSM) and the K2 Australian Fund.