Wednesday, November 7, 2012

Equifax is a Stock to Benefit From QE3

Here we go again. Another round of QE and another pop at stimulating the economy by pumping liquidity into it and keeping interest rates low. I’m not saying it’s right, I’m not saying it’s wrong but what I am saying is that it is usually a good idea not to fight the Fed and try to invest in line with what they are doing. With that in mind I think shares in Equifax (NYSE: EFX) are well worth a look.

The investing thesis runs like this. If the Fed is going to keep rates low and try to get the banks to lend then consumption will inevitably pick up. This leads to growth and then loan demand. Given that most credit quality ratios are indicating US households have significantly tied up their balance sheets and employment gains are up then it is surely time for the banks to start lending. And when the banks lend, the primary credit bureaus start making money.

Equifax’s Prospects

The three major private credit bureaus are Equifax, privately held TransUnion and UK listed Experian. Fair Isaac (NYSE: FICO) also has a division that sells consumer data but the previous three are the main protagonists. All three credit reporting agencies (Equifax, Experian and TransUnion) use Fair Isaac to produce their FICO scores. Therefore, the company is a useful indicator and a good way to get exposure to the credit bureaus prospects.

A quick look at Equifax’s divisional revenues ($m) in the last quarter.

The core US Consumer Information Services (USCIS) division is the key to its earnings as it is largely responsible for the marginal movements in Equifax’s income. In the last quarter, this division reported a 19% increase in revenue. Within which online consumer information went up 20% to $153.4 million and mortgage solutions rose a whopping 51% to $40.6 million. Consumer Financial Marketing fell 9% to $36.1 million.

It’s understandable if investors awaited the international results with trepidation but somehow Equifax managed to get revenues up 9% on a local currency basis (excluding the divested Brazil operations). The UK was cited as an area of strength in the conference call and that doesn’t surprise me. The country can’t seem to lose its addiction to debt.

Workforce solutions had a strong quarter with a 20% increase in revenue accompanied by a 180bp improvement in operating margins to 23.4%. The mortgage market made a good contribution to the Workforce numbers. This division competes with companies like Automatic Data Processing (NASDAQ: ADP) and Paychex (NASDAQ: PAYX) There are concerns over competition in this industry possibly affecting pricing, but the fact that Equifax keeps expanding margins is a sign that competition is not as tough as people think.

Turning to the last two divisions, North America Personal Solutions rose 12% while Commercial Solutions displayed ongoing weakness by falling 2%.

In summary, the last results were quite strong and confirm on ongoing recovery in US credit issuance and in particular strong growth in mortgages.

What is the Industry Saying?

With regards the workforce division, its competitor ADP confirmed its full year guidance for 12% growth in its employer services and PEO services businesses (the bit that competes with workforce). I think this is a pretty strong performance although investors interested in ADP should note that a low interest rate environment hurts ADP because of lower yields on its client fund portfolio.

Turning to Paychex, the company recently reported its highest service revenue in its history and the key checks per payroll metric has improved for the last nine quarters in a row. So far there is no sign of the moderation in this growth that its management had suggested would happen previously.  The stock yields 3.7% and is well worth a look as a play on an ongoing US recovery.

On a less positive note, Fair Isaac’s last results saw flat scores revenues. Although interestingly its B2B scores growth was much better than its B2C numbers. Note that this contrasts with what Equifax reported for North America personal and commercial solutions.

As for commentary on what the mortgage market is doing, look no further than Wells Fargo with its large and growing share of US mortgage issuance. The bank has been making progressively bullish noises throughout the year on the mortgage environment and housing in general. I think it remains one of the best ways to play the theme. There has been some recent chatter about net-interest margin compression due to low rates, but there is a reason why interest rates are this low. It is to stimulate the economy so the banks can issue more credit. After all, that is how they make money!

Where Next for Equifax?

Revenues were predicted to rise 9-11% in Q3. I wouldn’t expect any upside in the near term from QE3. However, the authorities are determined to pump liquidity into the system and that will only mean that lending and Equifax’s prospects are being supported by the Fed’s actions. I think Equifax was attractive even before QE3 was announced but it is even more so now.

Management have returned nearly 50% of cash from operations over the last two years which is a sign that they are aligned with shareholder interests. Now given that the stock is on a current FCF/EV valuation of 6.1% with low teens earnings growth forecast for the next two years I think the stock is cheap. Throw in the upside from QE3 and it is very attractive.