EML Payments — Improving outlook

Exhibit 1 summarises EML Payment’s H122 performance. We discuss the performance on a divisional basis below. The 209% y-o-y growth in gross debit volume (GDV) reflects the addition of Sentenial from 1 October 2021, contributing GDV of $19.5bn, which implies organic GDV growth of 18% y-o-y. As Sentenial has a much lower yield, its consolidation had a smaller impact on revenue, contributing only 2.8% of the 20% y-o-y growth at the group level. Two factors weighed on group gross profit: a lower level of interest income earned on cardholder stored value (A$2.7m lower year-on-year/2.4pp impact on gross margin) and reduced establishment fees in GPR due to the ongoing regulatory issues.

Group EBITDA of A$14.2m declined 49% y-o-y, reflecting lower gross margin, the increase in underlying overheads (+24% y-o-y to A$48.5m) as the company strengthened its compliance function (investing in people, technology and controls) and the addition of Sentential overheads. It also reflects an additional $12.7m in costs incurred dealing with regulatory issues (for more detail see section on page 3). Stripping out the one-off regulatory costs, underlying EBITDA decreased 4% y-o-y. The company’s preferred profit measure, NPATA, declined 68% y-o-y due to the same issues. Adding back the after-tax cost of dealing with regulatory issues, underlying NPATA grew 6% y-o-y.

The company closed H122 with a net cash position of A$0.2m, made up of A$86.2m in cash offset by the $39.2m present value of the loan notes owing to PFS and debt of $46.8m put in place to fund the Sentenial acquisition during H1. Cash flow in H122 was affected by several items:

The G&I division reported a stronger performance than a year ago, reflecting the fact that for much of H122, lockdown restrictions were lifted allowing mall footfall to improve. GDV increased 21% year-on-year, with mall GDV up 26% y-o-y. Compared to the pre-COVID period of H120, GDV was up 9% for the division and up 6% for the malls business. With the emergence of the Omicron variant just before Christmas, governments in Canada, Germany and the UK re-introduced some restrictions and consumers also self-policed, unwilling to catch COVID in the days running up to Christmas. The company estimates that this temporary reduction in footfall probably cost it c A$100m in GDV which would have dropped through to c A$6m in revenue and c A$5m in gross profit. The reward and incentives business grew GDV only 4% y-o-y, reflecting a very strong period in H121 for COVID-19 programmes. Divisional revenue grew 6% year-on-year; in H121, the company reported elevated breakage revenue of A$5m, which did not repeat in H122 as mall volumes reverted to more normal levels.

GPR GDV grew 29% y-o-y, with strong demand from gaming disbursements and salary-as-a-service and, as the yield was essentially flat y-o-y, revenue grew 28% y-o-y. The company noted that it was implementing opportunities to reduce dormant state balances and during H122 recognised revenue of A$5.0m on its commencement. Gross margin declined by 6.4pp due to a combination of lower establishment fees (see below) and lower interest income.

The company continues to work through its remediation plan to deal with the issues raised by the CBI regarding PFS Card Services Ireland Limited (PCSIL). PCSIL is the Irish subsidiary through which the GPR division manages European business. The company expects to complete the plan by the end of Q322, after which it will seek an external party review of its work. Currently, the CBI has placed limits on the amount of growth PCSIL can generate – this restriction is in place until December. To ensure PCSIL can still grow during this period without hitting the limit, the company is phasing out some high-volume/low-yielding programmes to make room for more attractive programmes. It previously provided for costs of A$10m relating to this issue; in H122, it incurred/provided an additional $2.2m in costs and used A$2.8m of the provision.

As certain programme launches were put on hold and the company sought fewer new contracts in this division, the growth of establishment fees was lower than transaction-related revenue (18% and 23% y-o-y growth respectively). Establishment fees for programmes on hold were recognised in FY21 and the lower level of new contracts in H122 could not compensate for this. By December 2021, PCSIL was able to start launching programmes again and managed to launch 22 by the end of H122.

In December 2021, Shine Lawyers filed group proceedings in the Supreme Court of Victoria, claiming that EML did not comply with disclosure obligations and engaged in misleading and deceptive conduct regarding disclosure of the CBI issue. The company disputes this but has provided $10.5m for fees to fight the case, with an expected timeframe of three years or so. Management intends to seek an order for security from Shine to cover a fee award if EML wins its case. EML does have an insurance policy in place to cover this issue but has not yet met the criteria required for it to be recognised; this is unlikely to be the case until FY23.

Sentenial was consolidated into this division from 1 October 2021. Divisional GDV grew 431% y-o-y or 7% on an organic basis. Of the $19.5bn contributed by Sentenial, $19.12bn was from direct debit and $0.33bn from open banking. The company noted that open banking volumes increased 30% in H122 versus H121 on a pro forma basis. Sentenial contributed A$2.7m of divisional revenue, implying an organic divisional revenue decline of 14%. As Sentenial earns a much lower yield (c 1.4bp) than the original Digital Payments business (12bp in FY21), the overall divisional yield has fallen to 3bp and will decline further in H222 as Sentenial is included for a full six months.

Management noted that the integration of Sentenial’s technology with EML’s platform is underway and it has started targeting prospects with combined prepaid/open banking solutions, with the first such contract win expected in Q322.

Across the group, and excluding Sentenial, EML signed 33 new contracts in H122 and implemented 85 new programmes. This included 22 new programmes in GPR in Europe. The company has maintained its 40% pipeline conversion rate and has contracts in the pipeline that could be worth annual GDV of $13.6bn by the third or fourth year of the contract (up from A$10.5bn at the end of FY21).

The company has pointed to several factors that should benefit gross margin in H222:

In H222, the company will also start to transition two major customers onto its TRACE proprietary processing platform. This is expected to result in savings of c A$3m in FY23.

While the investment in strengthening the compliance function has had a short-term impact on EBITDA profitability, the company believes that this positions it well as volumes grow. In addition, this level of investment creates a barrier to entry for potential competitors.

The company has maintained its FY22 guidance (see Exhibit 2). We have revised our forecasts to reflect H122 performance and guidance (see Exhibit 3). We have increased our GDV, revenue and gross profit forecasts for the GPR and G&I divisions, based on better-than-expected performance in H122 and measures being taken to improve H222 performance. We have revised down our Digital Payments GDV forecasts reflecting slower growth in the Sentenial business, although at a much lower yield, this has a much smaller impact at the revenue level. Overall, our forecasts remain at the lower end of company guidance for FY22.

In FY23 (when we expect the first positive contribution from Sentenial, NY in the table), EML is trading at a discount to global payment processor peers on an EV/EBITDA and P/E basis, reflecting the profitability and scale of peers. Having previously traded at a premium, it is now trading at a discount to prepaid card peers on an EV/Sales basis and only a small premium on an EV/EBITDA basis. Prior to the CBI issue, EML was trading on an FY23e EV/EBITDA of 21.4x and an FY23e P/E of 37.5x. If the regulatory issue is successfully resolved without imposing material growth constraints on the European business, we would expect the stock to re-rate upwards.