Why EML is a core holding in our Small Companies Fund

We recently launched the Montgomery Small Companies Fund.  This new fund has invested in some truly dynamic businesses that we believe will deliver superior returns over the coming years.  One of those is EML Payments (ASX: EML).

EML is one of our fund’s initial top five holdings. It’s a structural growth company with multiple growth drivers and identifiable near-term positive share price catalysts. EML was a clear standout at the most recent results season (40 per cent FY19 EBITDA growth, solid earnings beat, market forecasts upgraded) and we expect a positive outlook to be reaffirmed at the investor day scheduled for November 2019. Indeed, FY20 consensus earnings estimates appear relatively conservative so we see scope for EML to issue better than expected earnings guidance.

Capped at just over $1 billion, EML is a ‘fintech’ company specialising in issuing and distributing mobile, virtual and physical card solutions to corporate clients across Australia, Europe and North America. The company processed $9 billion of payments (defined as gross debit volume or GDV) in FY19 (grew 34 per cent over the prior year) and manages more than 1,400 programs across 23 countries.

EML’s competitive advantage and point of differentiation versus the incumbent banks is its innovative approach to designing and implementing efficient payment solutions for customers across a number of industry sectors. More than just a simple card issuer, EML leverages its highly scalable technology platform to provide a full end-to-end payments solution to clients, from initial implementation through to after sales support. Contracts are typically five years in duration and client churn has been negligible with EML’s platform deeply entrenched in customer ERP and payments systems, making it hard to displace. Operating in a regulated industry, barriers to new entrants are also high.

Revenue is generated through various stages of a transaction life cycle, from set-up fees, transaction fees, interchange and breakage fees as well as interest earned on loaded funds. The business model has a number of attractive characteristics, including being capital light and having high gross margins (77 per cent heading to 80 per cent plus) coupled with relatively fixed overheads, resulting in a high cut through of incremental volumes (highly scalable business).

The company has strategically targeted a number of very large and fast-growing industry verticals requiring innovative and customised payment solutions, such as salary packaging, shopping mall gift cards, gaming and wagering services and consumer lending.

EML is now the global leader in managing non-reloadable gift card programs for shopping mall clients, supporting over 900 malls, mostly across Europe (+600) and North America (+200). Displacing inefficient traditional paper based gift vouchers, typically issued and managed inhouse, EML sees strong growth prospects for this unit, particularly in Europe where a large German mall operator plans to roll-out EML’s program across more of its locations.

Online gaming and wagering is another large and growing market opportunity for the company. EML is currently managing 13 reloadable card programs for gaming clients located in Australia, Europe and North America; management expect this to expand to 30 programs by 2022.

To give a sense of the size of the prize, the online gaming market in Australia is estimated to be $12 billion, Europe $38 billion and North America $90 billion. The progressive opening up of the US sports betting market (now legalised in 11 states with many more anticipated to follow) represents a significant opportunity for EML which launched its first program with Pointsbet in New Jersey in January 2019 with bet365 anticipated to commence soon. Legalised US sports betting is rapidly evolving and we think EML is very well placed to capitalise on this change –  US gaming could support five to ten year’s growth for the company.

Taking advantage of the void left by the major domestic banks retreating from the sector, EML has established a dominant position in the Australian salary packaging reloadable cards segment (70 per cent share). The recent Smartgroup contract to transition the remainder of their portfolio will drive further growth over the next two years.

We view EML as a well-managed, high quality structural growth company with upside earnings risk and balance sheet optionality ($18 million of net cash as at 30 June 2019). When assessing a valuation for EML, we believe short-term earnings multiples do not appropriately capture the medium-term potential of the business. The stock is trading on 20x FY21 EBITDA (consensus estimates). However, this multiple falls to single digits three years further out (based on our projections). As such, we believe some vision is required and, on what we can see, this investment looks compelling.

The Montgomery Small Companies Fund own shares in EML Payments.  This article was prepared 03 October with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade EML Payments you should seek financial advice.


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