October 26, 2016
DH Corporation
Downgrading to Sector Perform; Q3/16 miss and outlook weaker than expected
Our view: Q3/16 EPS missed consensus by 20% and reduced guidance for the second consecutive quarter suggests that fundamentals are materially weaker than we expected. Low earnings visibility and the absence of a near-term catalyst are likely to limit significant valuation upside. We had hoped that DH’s fundamentals would gradually improve with evidence of stronger growth in 2017. This appears unlikely and we downgrade to Sector Perform.
Key points:
Disappointing Q3/16 on multiple fronts: (1) EPS of $0.49 vs. RBC at $0.56 and $0.61 consensus [range of $0.55–0.66]; (2) revised guidance which appears reduced from before; (3) although Canada/U.S. lending solutions revenues were in line, Canadian payments, GTBS, and U.S. integrated core missed and consolidated EBITDA margins were 320bps below our forecast; (4) first real evidence that Canadian cheque revenues are declining, with estimating the rate of decline likely to be a greater focal point for investors; and (5) GTBS results disappointed again.
Downgrading to Sector Perform (from Outperform); reducing 12-month price target to $26 (from $48). The reduced target reflects both lower financial forecasts and a lower target P/E multiple (was 15.5x, now 11.5x, which is where DH traded prior to Q3/16 earnings being released). DH trades at a significant valuation discount to U.S. peers, but we think valuation multiple expansion is unlikely in the near term given a more cautious outlook.
We think DH has become a “show me” story. Shares have potentially substantial upside, but early signs of a catalyst are needed. Earnings releases/outlook disappointed in the last three quarters. DH’s share price is down ~30% in the past year and the stock trades at a significant discount to U.S. peers, so we think the share price already reflected some growth concerns. We think early and sustainable signs of significant improvement in most of DH’s segments (particularly GTBS and U.S. lending solutions) are key to getting the stock going again.
The dividend conundrum. We believe DH is still significantly owned by retail investors, who we think understand the company’s repositioning from a lower-growth high-yielding income trust to a higher-growth FinTech story but still enjoy the nice dividend yield. Given the significant share price decline and U.S. peers with a nominal or no dividend yield, we believe it may be worth considering a dividend reduction to buy back stock and/or de-lever (a 1.5% dividend yield could allow de-levering of ~0.2x EBITDA annually), which would likely be negative for the share price initially but may be beneficial longer-term. Our forecasts assume no change to the dividend