New Zealand Professional Investment Services Firm

Forsyth Barr

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Forsyth Barr is a foundation New Zealand Exchange firm (NZX) and accredited market participant. We have been confirmed by the Financial Markets Authority as a Qualifying Financial Entity (QFE).

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Gentrack</h2>
FY19 — Legacy Drag on SaaS
We downgrade our rating on Gentrack (GTK) to UNDERPERFORM from NEUTRAL as a result of repeated profit warnings during FY19, reduced confidence in the near to medium term earnings outlook, and valuation concerns given it trades at ~35x one year forward PE. The shape of the FY19 result suggests profitability is being held back by (1) challenging industry conditions in core markets, and (2) its transition to SaaS (software-as-a-service). The latter is providing a higher quality revenue stream but appears to be having a negative impact on margins.
What’s changed?
<ul>
<li>Earnings: Significant cuts to FY20 and FY21</li>
<li>Target Price: Lowered from NZ$5.50 to NZ$4.20</li>
<li>Rating: Downgraded to UNDERPERFORM from NEUTRAL</li>
</ul>
The good, the bad and the ugly of FY19
The good: annual recurring revenues now at ~70% of total.&nbsp;The bad: bad debts of NZ$2.4m contributed to the EBITDA decline but don’t explain the full margin decline.&nbsp;The ugly: outlook commentary and withdrawal of +15% longer term organic growth target creates uncertainty over the future growth trajectory.
FY20 guidance creates uncertainty
Management has provided FY20 EBITDA guidance “broadly flat” relative to FY19, despite (1) the level of bad debts likely to fall, (2) cycling CA+ losses; now breakeven, and (3) growing recurring revenue. This suggests the legacy on-premise business will continue to significantly drag on earnings. In reality, we think the degree of unpredictability of the non-recurring earnings means providing guidance at this stage of the financial year is futile.
Valuation of project services revenue stream questionable
Legacy revenue streams (including licensing and project services) declined by -19% in FY19. These now represent ~29% of group revenue (in FY17 they contributed ~42%). Given new customers are more likely to be signed up under a SaaS based revenue model we think it is safe to assume that this legacy revenue stream will head towards zero over the medium term. As a result investors should be paying relatively little for this compared to SaaS earnings.&nbsp;
Lower longer term margins?
GTK’s margins have been on a downwards track since prior to listing in 2014. While FY19 margins were adversely impacted by a number of non-recurring items, we no longer believe margins can recover to historic levels. First, we are wary of the mix shift in the business from the legacy on-premise software approach to SaaS. This is great from a business quality and certainty point of view, but we suspect margins are being sacrificed. Second, we are wary of industry competition. New entrants, particularly in the UK, are actively targeting smaller utility providers with aggressive pricing.&nbsp;
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Investment View
GTK is a profitable niche software company, providing specialist business critical software for utilities and airports, with an attractive longer term global growth opportunity driven by sustainable secular trends. It has been migrating to an SaaS model in recent years. At the same time margins have declined and revenue impacted. The earnings downgrade cycle of the past two years has been severe. Our rating is UNDERPERFORM.&nbsp;
</div>
Andy Bowley andy.bowley@forsythbarr.co.nz +64 4 495 8246

Gentrack
FY19 — Legacy Drag on SaaS
We downgrade our rating on Gentrack (GTK) to UNDERPERFORM from NEUTRAL as a result of repeated profit warnings during FY19, reduced confidence in the near to medium term earnings outlook, and valuation concerns given it trades at ~35x one year forward PE. The shape of the FY19 result suggests profitability is being held back by (1) challenging industry conditions in core markets, and (2) its transition to SaaS (software-as-a-service). The latter is providing a higher quality revenue stream but appears to be having a negative impact on margins.
What’s changed?

Earnings: Significant cuts to FY20 and FY21
Target Price: Lowered from NZ$5.50 to NZ$4.20
Rating: Downgraded to UNDERPERFORM from NEUTRAL

The good, the bad and the ugly of FY19
The good: annual recurring revenues now at ~70% of total.&nbsp;The bad: bad debts of NZ$2.4m contributed to the EBITDA decline but don’t explain the full margin decline.&nbsp;The ugly: outlook commentary and withdrawal of +15% longer term organic growth target creates uncertainty over the future growth trajectory.
FY20 guidance creates uncertainty
Management has provided FY20 EBITDA guidance “broadly flat” relative to FY19, despite (1) the level of bad debts likely to fall, (2) cycling CA+ losses; now breakeven, and (3) growing recurring revenue. This suggests the legacy on-premise business will continue to significantly drag on earnings. In reality, we think the degree of unpredictability of the non-recurring earnings means providing guidance at this stage of the financial year is futile.
Valuation of project services revenue stream questionable
Legacy revenue streams (including licensing and project services) declined by -19% in FY19. These now represent ~29% of group revenue (in FY17 they contributed ~42%). Given new customers are more likely to be signed up under a SaaS based revenue model we think it is safe to assume that this legacy revenue stream will head towards zero over the medium term. As a result investors should be paying relatively little for this compared to SaaS earnings.&nbsp;
Lower longer term margins?
GTK’s margins have been on a downwards track since prior to listing in 2014. While FY19 margins were adversely impacted by a number of non-recurring items, we no longer believe margins can recover to historic levels. First, we are wary of the mix shift in the business from the legacy on-premise software approach to SaaS. This is great from a business quality and certainty point of view, but we suspect margins are being sacrificed. Second, we are wary of industry competition. New entrants, particularly in the UK, are actively targeting smaller utility providers with aggressive pricing.&nbsp;

Investment View
GTK is a profitable niche software company, providing specialist business critical software for utilities and airports, with an attractive longer term global growth opportunity driven by sustainable secular trends. It has been migrating to an SaaS model in recent years. At the same time margins have declined and revenue impacted. The earnings downgrade cycle of the past two years has been severe. Our rating is UNDERPERFORM.&nbsp;

Andy Bowley andy.bowley@forsythbarr.co.nz +64 4 495 8246

Gentrack

Gentrack: FY19 — Legacy Drag on SaaS