EML Payments — Strategic review for sustainable growth

EML reported GDV of A$80.2bn, within the guidance range of A$79–84bn. This equated to growth of 308% y-o-y or 19% when excluding the contribution from the Sentenial acquisition (completed on 1 October 2021). Revenue of A$234.1m was at the upper end of the guidance range of A$225–235m, with 21% growth y-o-y and 17% growth on an organic basis. On a reported basis, revenue was A$232.4m after A$1.7m of bond amortisation.

Gross profit of A$157.8m (+23% y-o-y) equated to a gross margin of 67.9%, marginally below the guidance of 69% but up 1pp y-o-y.

Underlying EBITDA of A$51.2m was below the guidance range of A$52–55m and our A$52.1m forecast. Underlying EBITDA excludes A$16.9m in costs related to the Central Bank of Ireland (CBI) issue (we had forecast these costs to be A$15m). Overheads of A$108.4m were at the upper end of the expected A$106–109m range reflecting investment in risk and compliance in the European business.

Normalised operating profit of A$18.4m was below our A$23.2m forecast, reflecting lower underlying EBITDA and higher than expected amortisation. Reported operating profit of A$0.3m was well ahead of our forecast for a A$7.5m loss. Items included in reported operating profit include share-based payments of A$3.0m (vs our A$6.0m forecast), amortisation of acquired intangibles of A$16.5m (vs our A$20.0m forecast), an FX gain of A$6.1m (vs our $0.2m loss forecast) and other one-off items totalling A$1.2m (vs our A$2.0m forecast).

The outstanding contingent consideration owing to the PFS vendors of A$15.2m at the end of H122 was written down to zero during H222 – this resulted in a fair value gain of A$13.6m and removed the A$1.6m unwind of the discounted value that we had forecast. The company also wrote the value of its stake in Hydrogen down to zero, resulting in a fair value loss of A$7.3m.

Underlying NPATA of A$32.1m was well ahead of the guidance range of A$27–30m and our A$27.5m forecast. Underlying NPATA excludes the post-tax, CBI-related costs totalling A$12.7m (our forecast A$12.0m). The main reason for the outperformance was the lower-than-expected reported net loss of A$4.8m (the starting point for the NPATA calculation).

The company closed the year with net debt of A$9.7m (gross cash of A$73.7m, syndicated debt facility drawdown of A$45.8m and A$37.6m in interest-bearing deferred consideration). This was below our forecast for net cash of A$42.6m, mainly due to higher than forecast working capital requirements. Around a third of this was due to the account management fee (AMF) recognition within contract assets, which will be received as cash in the coming years. The remainder resulted from higher trade debtor days and a lower level of trade payables than expected. Other than the working capital movements described above, the main items reducing net cash over the year included payment of A$57m for Sentenial, the A$28m injected into segregated funds to cover accelerated recognition of breakage in PFS prior to acquisition (see page 4 of Moving forward for further explanation) and A$14m in capex. We note that as with the account management fees described above, the A$28m injected into segregated funds should be received in cash over time.

G&I revenue growth of -3% y-o-y reflected 21% growth in GDV offset by a lower yield of 510bp (FY21: 635bp). While volume growth benefited from higher footfall in shopping malls as lockdowns were lifted, the emergence of Omicron towards the end of CY21 dampened demand over the Christmas period. In FY21, the company reported A$11.1m in excess breakage revenue resulting from reduced gift card usage during COVID. Breakage returned to more normal levels in FY22 as shoppers returned to malls and, as breakage generates a 100% gross margin, this reduced gross margin by 1.4pp y-o-y to 79.8%.

GPR revenue grew 30% y-o-y, with GDV up 27% and yield up 3bp to 120bp. Demand was strong in Europe and Australia, although the CBI regulatory issue affected the number of new programmes that could be launched and therefore reduced establishment fee income. The business introduced AMF during the year for accounts that have been inactive for more than 12 months; these totalled A$23.5m during FY22, of which A$17.9m was non-recurring, and as these have a 100% gross margin, helped increase the divisional gross margin by 3pp y-o-y to 60.8%. Gross margins also benefited from the transition to in-house processing and the renegotiation of scheme arrangements.

DP benefited from the acquisition of Sentenial during H122. The original Virtual Account Numbers business saw a 4% revenue decline (GDV of A$9.8bn was up 10% y-o-y, yield was down 2bp y-o-y to 10bp) to A$9.8m. Sentenial contributed GDV of A$56.8bn and revenue of A$7.7m (yield 1.4bp), resulting in a divisional yield of 2.6bp.

Sentenial’s direct debit business was broadly flat y-o-y, with all growth coming from the Nuapay open banking business. Management noted that open banking volume was up 40% y-o-y on a pro forma basis and the business now has connections to 2,350 banks across 28 European countries with plans to take the technology to Australia. With blue chip customers already signed up (including payment gateways, merchant acquirers and financial institutions), the challenge now is to stimulate the use of open banking by customers’ merchants. EML expects to invest more in Nuapay in FY23, partly to provide support to customers to drive usage.

Since results were reported, the company announced that it had uncovered fraud within Sentenial’s direct debit processing business. It has identified a set of fraudulent merchants and believes that fraudulent transactions primarily took place in August. It has launched an investigation into how this happened and is seeking ways to recover the funds. Management estimates that the maximum loss will be €5.5m/A$7.9m and expects to be able to mitigate this via recovery actions.

Newly appointed CEO (11 July), Emma Shand, announced a strategic review of the business, with the outcome to be reported at the AGM in November. The aim of the review is to protect the base that has been built while ensuring that the business can grow in a sustainable way with a strong culture of regulatory compliance. Initial steps arising from the CEO’s first few weeks of reviewing the business include:

In July, the company provided an update regarding the ongoing regulatory issues between its Irish subsidiary, PFS Card Services (Ireland) Limited (PCSIL), and the CBI. EML’s remediation plan had a target completion date of 30 June, to be followed by a third-party assurance process. In the update, EML noted that the CBI had identified shortcomings in components of the remediation programme, principally the sequencing and approach taken to the risk assessment of its distributors, corporates and customers. PCSIL is adopting a revised approach to those components, which may include additional controls being embedded in its internal control framework. It anticipates that the third-party assurance will be finalised in 2023. As part of the remediation process, CBI has imposed growth limits on PCSIL – these are due for review in December. At this point, these caps are not restricting growth of the GPR division.

The company has decided to delay providing guidance for FY23 until the strategic review is complete, but highlighted that interest income should improve during the year as central banks around the world raise their rates. While the company reported interest income of A$1.4m for FY22, A$0.8m was generated in Q422. In July, interest income was A$0.5m before interest rate rises in the UK, eurozone, the US, New Zealand and Australia and, on the August run rate, interest income of at least A$10m is expected for FY23. Gross margin for FY23 is expected to be similar to FY22.

Our forecasts assume that all business divisions continue to operate as they do now. The main changes to our forecasts include:

In FY23, EML is trading at a material discount to global payment processor peers on all metrics. Having previously traded at a premium, it is now trading at a discount to prepaid card peers on an EV/Sales and EV/EBITDA basis. Repeated downgrades have reduced confidence in the outlook for EML. Factors that could help the stock to re-rate include the resolution of the regulatory issue without imposing material growth constraints on the European business, clawback of the costs of the Sentenial fraud and the outcome of the strategic review.