Saturday, July 28, 2012

Equifax Stock Analysis



Essentially, the recovery theory goes like this. Interest rates are cut, which encourages consumption, that leads to growth, and creates demand for loans, then the banks start lending again as they see employment gains and better credit quality ensues. Then we have the icing on the cake of a recovery.
All said, if you believe in the ongoing recovery, then the primary credit bureaus should be set for significant upside. The three major players are Equifax $EFX, privately held TransUnion and UK listed Experian. Fair Isaac $FICO also has a division that sells consumer data but the previous three are the main protagonists.

Moreover, Equifax is also good to look at from a bottom-up perspective on the strength of the recovery.


Equifax Beats and Raises Guidance

A summary of results and guidance
  • Q1 Revenues of $522.7m vs. estimates of $500m
  • Q1 EPS of 70c vs. estimates of 65c
  • Q2 Revenue guidance of $545-555m vs. estimates of $522m
  • Q2 EPS guidance of 70-73c vs. estimates of 68c
The key to these results was the unexpected strength from the mortgage sector within the core US Consumer Information Solutions (USCIS) division.  Overall, mortgages typically make up 14-22% of revenue and, currently, this is running in the high teens. 

This looks like a positive for the housing markets, but management was keen to dispel too much optimism by stating that they felt mortgage growth would slow after Q2. I suspect they are being cautious in order not to bake too much upside into analyst forecasts. We shall see.

One interesting aspect of the commentary was the circumspection poured over the accuracy of the MBA Mortgage Application Survey, of which, management does not think is a definitive measure of market activity. This is an interesting 'tell' because the survey is widely seen as the best indicator of mortgage demand. In addition, on the conference call, Equifax stated that underwriting standards at banks were ‘loosening’ especially at the lower end. Again, this is very interesting for the broader economy.

With regards to the importance of the core USCIS division, we can see that in a breakdown of quarterly profits here.



The cyclicality of total earnings is largely dependent on what USCIS does.


Equifax Reported Segments

The core USCIS division was up 20% in revenues and margins increased to 36.5% from 34.1% last year. Despite tougher comps, this division is seen as growing in double digits for the year with strength being broad based.

Equifax divested its Brazilian operations in Q2 of 2011, so over the years it has become an ever stronger play on US credit cycles. That said, international revenues (excluding Brazil) were up 15% in constant currency.  Equifax is forecasting double digit growth on the year, and declared that current trading in the UK is strong! This is perplexing, given the weakness in those two economies. The UK has just slipped into a recession and Spain’s housing prices are falling off a cliff. Go figure!

The next biggest division is TALX Workforce Solutions which competes with the likes of Automatic Data Processing $ADP and Paychex $PAYX.  Given that Equifax reported revenues up 14% and, expanded margins from 21.9% to 23%, this reads across well for these three companies. In addition, Equifax sees revenues up in upper single digits for the year. There has been some concern over competition in this industry possibly affecting pricing, but if Equifax can expand margins, then why can’t ADP or Paychex?

Turning to ADP's earning in January, the company raised revenue estimates for the key part of the business that overlaps with Equifax's TALX.
"Employer Services and PEO Services new business sales – we anticipate about 12% growth compared to $1.1 billion sold in fiscal 2011; this is up from our prior forecast of 8% to 10% growth"
As for Paychex, things do not seem so bullish. Revenues did increase 8% to the last quarter but management declared that "we believe that checks per payroll growth will moderate in the remainder of the year". However, Paychex said this, despite that metric improving for the last eight quarters in a row. We shall see if the guidance is too conservative.
Returning to Equifax, of the last two divisions, North America Personal Solutions revenue was up 11% although margins slipped a bit. The only disappointment was North America Commercial Solutions which saw only a 1% increase in revenues but a significant fall in margins to 16.8% from 24.9% last year. However, management is forecasting upper single digit revenue gains for the year.


Conclusion

I’m a great believer that you can read across many things from one company’s results to another’s. In this case, I think there is cause for optimism for Paychex, Fair Isaac and ADP. However, the striking improvement is in the performance of the mortgage division. Recently, banks like Wells Fargo WFC and JPMorgan have been making positive noises over the housing market passing a point of inflection. I’ve gone into more detail on this subject in a post linked here.
From these results, I think it is fair to assume that with its large and growing share of US mortgage issuance, Wells Fargo is a likely beneficiary. Throw in, improving credit quality conditions and, it is even more attractive. If you are looking for a ‘bread and butter’ bank with which to play the improving US economy than Wells Fargo is worth closer inspection.

I previously mentioned Fair Isaac, and the company recently gave results which saw its Scores revenues increase 8%. The Scores division currently acounts for around 28% of revenues and,  all three credit reporting agencies (Equifax, Experian and TransUnion) use Fair Isaac software to produce their FICO scores. Therefore, the company is a useful barometer for the industry and, an option as a way to get exposure.

As for Equifax, the evaluation looks attractive. I’m not so sure about international conditions remaining the same, but on the other hand, it is not a large part of profitability. I think Equifax offers upside from here, principally from its US operations, and pending continued growth in the US economy, it looks attractive.