MoneyTalks: Finding the sweet spot in the diversified financial space – here are 3 ASX stock picks
MoneyTalks is Stockhead’s regular drill down into what stocks investors are looking at right now. We’ll tap our extensive list of experts to hear what’s hot, their top picks, and what they’re looking out for.
Today we hear from Equitable Investors director Martin Pretty.
Pretty says the diversified financial sector appears to be a good hunting ground right now when seeking out businesses that are “growing nicely and priced on multiples that don’t demand much of them”.
“Some of these stocks have been caught up on the market downdraft despite their fundamentals, with worried investors prioritising liquidation over valuation,” he said.
“Others looked like good value to us before the recent market sell-off and have treaded water.”
Concerns about increased funding costs have weighed on companies that are in the lending game, Pretty adds.
“Certainly, the trend in the mortgage-backed securities market has been for widening spreads on top of increasing base rates (the one-month bank bill swap rate or BBSW, a key benchmark, has pushed to 0.31% now from around 0.015% in March).
“It is simplistic to turn negative on non-bank lenders just because of this one observation – there are a range of dynamics involved in funding costs and their impact on earnings, underlining just how important it is to understand the business you invest in.”
Another clear theme, according to Pretty, is that consolidation has been accelerating over the past year or so via ongoing “bolt-on” deals and the occasional large combination.
“Listed players have the opportunity to use their listings to finance deals by either issuing stock directly as consideration or by raising new capital,” he explains.
“Wealth platform player Hub24 (HUB) has been notable as an active buyer of smaller players that are complementary or strategic – a couple of months ago it completed the acquisition of cloud-based investment administration service Class.
“That followed deals struck in late 2020 to buy managed accounts platform business Xplore Wealth, broker Ord Minnett’s portfolio administration service, and over 30% of the equity in listed advice and accounting group Diverger.
“But HUB has certainly not been alone.”
MNY is a long-term growth story that Equitable Investors has been fortunate enough to have followed from a market cap of $50m through to $500m.
Over the last 10 years, earnings per share have grown >13% a year to $0.21 in FY21 from $0.06 in FY10. Along the way, MNY has been paying out a solid dividend stream – up to $0.13 a share from $0.04 a share.
“Today in our opinion, the company represents a well-run business with a seasoned management team and a history of delivering credible performance – for an approximate 10x P/E multiple, using forward estimates, and a 5.8% forecast dividend yield,” Pretty says.
“MNY is exposed to both the trends we’ve called out: it has been and continues to look to be an active consolidator of the automotive finance sector; and it is a lender exposed to market moves in the pricing of risk.
“But it is in the middle of reducing its funding cost and in the first half of FY22 its funding cost was down to 6.6% from over 11% a year ago.
“MNY is filling up newly secured warehouse facilities that have shifted its cost of funding downward – in 2021 it locked in a $NZ80m warehouse facility from Heartland Bank and $250m warehouse securitisation from Credit Suisse, in addition to its $100m in funding from a major Australian bank.”
Pretty’s second stock pick is a well-managed, growing, and strategic SME financier EPY.
He says the company is leveraging fintech and has already been subject to a takeover battle.
“EPY is one of the leading providers of alternative finance for small and medium businesses in Australia, primarily through invoice finance and also through equipment finance,” Pretty adds.
“It is growing EPS to nearly 6c this year (based on consensus estimates) from ~1c six years ago.
“The company’s income is effectively a margin charged on its Total Transaction Value (TTV).
“It borrows to fund its lending and has progressively lowered the interest rate it is charged from >10% in its early years to <3% for warehouse facilities today.
“In terms of its exposure to higher interest rates, we understand EPY charges its customers a rate that references the BBSW benchmark – so base interest rate rises are passed on.”
His last stock pic is expense management software company 8CO.
The company recently reported a 1% increase in March quarter revenue to $1.1m, with the number of users growing 7.9%. Annualised Recurring Revenue (ARR), inclusive of ongoing transactional revenue, was $3m.
“The key piece of context is that back in August 2021, 8CO announced its Expense8 expense management software solution had been mandated for a “whole-of-government” opportunity,” Pretty explains.
“The government awarded 8CO this opportunity as part of GovERP, a project to standardise software across federal departments.
“Over 90 Commonwealth agencies with over 130k employees participate in the shared services program that will now offer Expense8 (and another 79 agencies can opt in). Around 110k users in this group would be new to 8CO.
“8CO is not profitable yet but analyst estimates have it quickly getting to a single-digit PE multiple, factoring in significant revenue growth in FY23.”
Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.