Morgans Upgrade Hold to Add, page-2

Morgans note on LiveWire Markets
https://www.livewiremarkets.com/wires/cl1-gets-the-business-class-upgrade

Industry trends remain favourable to Class (CL1). Regulatory and compliance pressures will force most self-managed super funds to migrate record-keeping and administration to one of the two major cloud-based SMSF administration platforms, of which Class operates the fastest-growing.

With the stock now trading at a discount to our valuation, we upgrade our recommendation from Hold to Add.

Key points

• Class Limited (CL1) managed to meet market expectations despite the superannuation industry turmoil in late FY17 that slowed the rate of new customer on-boarding.
• Operating margins continue to expand nicely even though the company is investing heavily in sales and customer service.
• We increase our share price target, due mostly to the roll forward to a new base year.

Result as expected
Financial services platform operator Class (CL1) met expectations for FY17 for revenues and profits, despite regulatory disruptions to the superannuation and accounting industries. Core operating EBITDA grew 38% on 25% revenue growth as the company's operating leverage came to the fore. Despite heavy investment in building customer service and sales capacity, cash generation was excellent, with 89% of EBITDA turning into cash from operations.

Changes to forecasts, valuation
We have revised our forecasts to reflect:

1. slower new customer on-boarding in FY18;
2. deferral of the AMP exit from November 2017 to June 2018, which may be overly pessimistic; and
3. higher amortisation of internally-generated software and systems development costs.

Changes to our forecasts and the roll-forward to a new base year have resulted in an increase to our discounted cash flow valuation (A$3.55 per share; previously A$3.37). Note that our share price target is derived from our DCF valuation.

Risks and catalysts
Risks to earnings and the share price include:

1. failure to grow customer account numbers at the rate expected by the market;
2. regulatory changes slowing new SMSF formation; and
3. irrational competitor behaviour.

Potential near-term re-rating catalysts include:

1. stronger-than-expected growth in customer account numbers;
2. major new account wins; and
3. failure of competitors to launch competitive products.

Contributed by Ivor Ries, Senior Analyst; Sectors Covered: Information Technology, Online Media