Broadridge's Window Of Opportunity Is Closed

My last Broadridge Financial Solutions (BR) review was on May 11, 2022. At the time I considered its valuation to be attractive so I added to my exposure @ $138.43/share in a 'Core' account within the FFJ Portfolio. Now, however, Broadridge's window of opportunity is closed.

Now that BR has released Q4 and FY2022 results and its FY2023 guidance on August 12, 2022, I revisit it to determine how its valuation compares with that of my May review.

Retail Investor Call

BR is hosting its first-ever retail investor call on Thursday, August 18th at 6 PM ET.

Individual investors make up a large part of BR's shareholder base. Management is, therefore, hosting a call to provide a forum for investors to engage with the company directly and to learn more about BR's business.

Registration takes less than 1 minute. Click here if you wish to attend.

Overview

I encourage investors unfamiliar with BR to read:

BR operates its business in two reportable segments:

  • Investor Communication Solutions
  • Global Technology and Operations.

At its December 2020 Investor Day, BR laid out its three-year annual growth objectives; BR is currently on track to achieve these objectives.

Part of BR's overall business strategy includes acquisitions and strategic investments in companies, technologies or products, or joint ventures. Over the last 3 fiscal years, BR has completed 10 acquisitions and made strategic investments in 7 firms.

Itivity Integration

In May 2021, BR completed the ~$2.58B acquisition of Itivity Holdings AB (Itiviti). This acquisition strengthened BR's capabilities with a set of front-office trade order and execution management solutions, connectivity and network offerings which will integrate with our existing middle and back-office solutions.

This acquisition is now adding value.

BR - Itivity Is Delivering Value

Source: BR - Q4 and FY2022 Earnings Presentation - August 12, 2022

Financials

Q4 and FY2022 Results

This link leads to material related to BR's quarterly results.

BR delivered an 11th consecutive year of record closed sales, up more than 20%.

BR - Q4 and FY2022 Summary Financial Performance

Source: BR - Q4 and FY2022 Earnings Presentation - August 12, 2022

BR continues to increase the extent to which it generates recurring revenue. Within the earnings presentation is a breakdown of the recurring revenue generated from its Governance, Capital Markets, and Wealth & Investment Management franchises.

FY2022 recurring revenues rose 16%, driving higher margins and after accounting for higher interest expense, adjusted EPS growth of 14%.

BR - Recurring Revenue Growth FY2019 - FY2022

Source: BR - Q4 and FY2022 Earnings Presentation - August 12, 2022

BR - FY2022 Recurring Revenue Growth Drivers

Source: BR - Q4 and FY2022 Earnings Presentation - August 12, 2022

One of BR's drawbacks is that as a result of past acquisitions, it carries significant goodwill and other acquired intangible assets on the Balance Sheet (see Itivity Integration section above). In addition, BR can also defer certain costs to onboard a client or convert a client’s systems to function with its technology. Goodwill, intangible assets, net and deferred client conversion and start-up costs accounted for ~71% of the total assets on the FYE2022 Balance Sheet. Please refer to page 64 of 130 in BR's FY2022 Form 10-K for details about these deferred costs.

BR is not immune from the impact of inflationary pressures. Inflation has been evident from the perspective of attracting and retaining talent and material costs. Given these inflationary pressures and to prepare for a more uncertain economic environment, BR took a series of targeted cost actions in Q4.

  • Given the new hybrid work model, BR continues to rightsize its real estate footprint. NOTE: Since the beginning of the pandemic in 2020, BR has closed or reduced 49 offices or 14% of its total square feet.
  • It has also initiated additional business alignment initiatives in the form of a reduction in headcount.

While it has incurred one-time costs related to these initiatives, BR expects to realize $70 million in annualized savings.

BR is also closing its offices in Russia and will relocate associates wishing to move. In Q4, it incurred $1.4 million in expenses related to this effort and another $25 - $30 million is expected to be incurred over FY2023 to wind down the business in that market. Both the one-time real estate costs and the Russian wind-down expenses are excluded from BR's calculation of adjusted operating income and adjusted EPS.

FY2023 Guidance

Having just reported $6.46 in FY2022 Adjusted EPS, management's FY2023 7 - 11% adjusted EPS growth guidance means it is targeting ~$6.91 - ~$7.17 in adjusted EPS.

In FY2021 and FY2022, BR generated closed sales (in millions) of $232.1 and $281.9 (~21.5% growth). FY2023's closed sales guidance is reflected below.

BR - FY2023 Guidance - August 12, 2022

Source: BR - Q4 and FY2022 Earnings Presentation - August 12, 2022

BR's FY2023 forecast also includes the following:

EPS Growth Rate

  • Diluted EPS - GAAP: ~13-17% growth. FY2022 diluted EPS was $4.55 so FY2023's range is ~$5.14 - ~$5.32.
  • Adjusted EPS - Non-GAAP: 7 - 11% growth. FY2022 adjusted diluted EPS was $6.46 so FY2023's range is ~$6.91 - ~$7.17.

Operating Income Margin

  • Operating income margin % - GAAP: Increase of ~150 bps
  • Adjusted Operating income margin % - Non-GAAP: Increase of ~50 bps

Embedded in BR's adjusted EPS outlook is the impact of higher interest rates. This will result in a $35 - $40 million increase in interest expense. The impact of a stronger USD will lower adjusted EPS growth by just over 1%. While higher interest rates impact the interest expense line, the impact on BR as a whole is largely neutral because its ~$1.6B in variable debt outstanding is essentially matched by cash balances held in its mutual fund trade processing and stock transfer businesses. Management expects any increase in interest expense to be offset by an equivalent increase in float revenue in its Investor Communication Solutions.

Free Cash Flow (FCF)

BR is a growth company, and therefore, its capital allocation model remains focused on balancing investment for long-term growth and capital return to benefit shareholders.

BR's FY2011 - FY2022 FCF (in millions of $) is 167, 238, 220, 334, 365, 362, 312, 556, 544, 500, 539, and 370.

In FY2021, BR generated ~$539.4 million in FCF or ~$557.3 million if we include $18 million in proceeds from asset sales.

FY2022 FCF was ~$370.4 million (~$443.5 million in net cash flows provided by operating activities minus $73.1 million in capital expenditures and software purchases and capitalized internal-use software). There were no proceeds from asset sales.

BR is in a peak period of investment across multiple client platforms. This includes the wealth platform which is on track to complete coding in FY2023.

Management also expects client platform investment to be lower in FY2023 with FCF conversion returning to more historical levels in FY2024.

Credit Ratings

As of FYE2022, BR had $3.793B in aggregate principal amount of total debt. Additionally, its revolving credit facility has a remaining borrowing capacity of $1.475B as of the same date.

In FY2022, BR repaid $95.5 million of debt. It continues to prioritize debt repayment over share repurchases until it reaches a leverage ratio that is in line with the objective to maintain an investment-grade credit rating.

All BR's domestic senior unsecured debt ratings are at the top tier of the lower-medium grade investment-grade category and are unchanged from the time of my last review.

  • Moody's: Baa1 with a negative outlook;
  • S&P Global: BBB+ with a negative outlook;
  • Fitch: BBB+ and a stable outlook.

These ratings define BR as having an ADEQUATE capacity to meet its financial commitments. Adverse economic conditions or changing circumstances, however, are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.

Even if the ratings are downgraded two tiers, the definition reflected above still applies.

I view BR's credit risk as acceptable for my purposes.

Dividends and Share Repurchases

Dividend and Dividend Yield

As I compose this post, BR's dividend history has yet to be updated to reflect the dividend increase announced on August 12, 2022.

In my May post, I indicated that I expected the 4th quarterly $0.64/share dividend to be declared in June for distribution in July; this occurred.

I also envisioned a ~$0.05/share dividend increase effective with the October dividend payment. Based on my assumption, I stated that investors might expect the next 4 quarterly dividends to total $2.71 (1 @ $0.64 and 3 @ $0.69). Using my recent ~$138.43 purchase price, the projected forward dividend yield was ~1.96% which was superior to the dividend yields at the time of my previous posts.

I underestimated the magnitude of the dividend increase!

On August 11, 2022, BR's Board declared a quarterly dividend of $0.725/share payable on October 5, 2022 to stockholders of record on September 15, 2022. This represents a 13% increase from $2.56 to $2.90/share ($0.64/quarter to $0.725/quarter). With this increase, BR's annual dividend has increased for the 16th consecutive year since becoming a public company in 2007. It has also reported double-digit dividend increases in 9 of the last 10 years.

With shares trading at ~$183, the new dividend yield will be ~1.6%. Despite the magnitude of the dividend increase, BR's share price has risen so much after my last review that the dividend yield is less appealing. Having said this, dividend metrics should have minimal bearing on investment decisions. The focus should be on risk exposure and total long-term potential investor return.

Share Repurchases

The weighted average diluted shares outstanding in FY2011 - 2021 were 128.3, 127.5, 125.4, 124.1, 124, 121.6, 120.8, 120.4, 118.8, 117, and 117.8 (millions of shares); this increased to 118.3 in Q1 2022, reduced to 117.6 in Q2, increased to 118.5 in Q3, and remained at 118.5 in Q4.

Negligible share repurchases are being made as BR works toward reducing the debt used to acquire Itiviti.

Valuation

My last major BR purchases were in November 2018 and February 2019.

At the time of my November 2018 purchase, BR's share price had retraced to ~$105. Based on reaffirmed guidance, BR’s forward PE was ~25.4 - ~26.3 and its forward adjusted PE was ~22.2 - ~22.98.

In February 2019, guidance had just been reaffirmed and using the ~$95.80 share price, the forward PE range was ~23.2 - ~24 and its forward adjusted PE range was ~20.3 - ~20.96.

In early December 2021, shares were trading at ~$171 and broker guidance was:

  • FY2022 - 8 brokers - mean of $6.43 and low/high of $6.22 - $6.65. Using the mean, the forward adjusted diluted PE is ~26.6.
  • FY2023 - 8 brokers - mean of $7.05 and low/high of $6.89 - $7.31. Using the mean, the forward adjusted diluted PE was ~24.3.
  • FY2024 - 3 brokers - mean of $7.46 and low/high of $7.35 - $7.55. Using the mean, the forward adjusted diluted PE was ~23.

When I purchased shares in early February @ ~$151, the forward adjusted diluted PE based on current broker guidance is:

  • FY2022 - 8 brokers - mean of $6.40 and low/high of $6.22 - $6.50. Using the mean, the forward adjusted diluted PE is ~23.6.
  • FY2023 - 8 brokers - mean of $7.08 and low/high of $6.90 - $7.32. Using the mean, the forward adjusted diluted PE was ~21.3.
  • FY2024 - 3 brokers - mean of $7.42 and low/high of $7.35 - $7.54. Using the mean, the forward adjusted diluted PE was ~20.4.

On May 9, 2022, I acquired additional BR shares @ $138.43 at which time the forward adjusted diluted PE levels were as follows:

  • FY2022 - 8 brokers - mean of $6.45 and low/high of $6.31 - $6.50. Using the mean, the forward adjusted diluted PE is ~21.5.
  • FY2023 - 8 brokers - mean of $7.06 and low/high of $6.88 - $7.32. Using the mean, the forward adjusted diluted PE was ~19.6.
  • FY2024 - 5 brokers - mean of $7.55 and low/high of $7.37 - $7.85. Using the mean, the forward adjusted diluted PE was ~18.3.

FY2023 guidance includes a diluted EPS forecast of ~13 - ~17% growth. FY2022 diluted EPS was $4.55 so FY2023's range is ~$5.14 - ~$5.32. Shares are currently trading at ~$183 which leads to an FY2023 diluted PE range of ~34.3 - ~35.6. In contrast, BR's diluted PE in FY2012 - FY2021 is 21.58, 20.69, 22.86, 22.96, 26.21, 31.89, 25.46, 31.68, 38.01, and 39.2.

Having just reported $6.46 in FY2022 Adjusted EPS, management's FY2023 7 - 11% adjusted EPS growth guidance means it is targeting ~$6.91 - ~$7.17 in adjusted EPS. Using a ~$183 share price the FY2023 adjusted diluted PE range of ~25.5 - ~26.5.

Current broker guidance has yet to be updated. For now, however, BR's valuation based on current broker estimates is:

  • FY2023 - 6 brokers - mean of $7.06 and low/high of $6.88 - $7.28. Using the mean, the forward adjusted diluted PE is ~26.
  • FY2024 - 3 brokers - mean of $7.51 and low/high of $7.45 - $7.62. Using the mean, the forward adjusted diluted PE was ~24.4.
  • FY2025 - 1 brokers - mean of $8.05 and low/high of $8.05 - $8.05. Using the mean, the forward adjusted diluted PE was ~22.7.

I think the window of opportunity to acquire BR at a reasonable valuation is currently closed.

Final Thoughts

I have been an Automatic Data Processing (ADP) shareholder for ~2.5 decades. From this investment, I became a BR shareholder the day it was spun off from ADP in April 2007. For several years, BR flew under the radar. It was, however, added to the S&P 500 Index at the opening of trading on June 18, 2018. Now, BR is widely followed so the opportunity to acquire very attractively valued shares rarely occurs. Investors should not, therefore, expect BR's valuation to be in the teens before acquiring shares.

Over the years, I have increased my BR exposure. I now hold shares in a retirement account for which I do not disclose details and in a 'Core' account and a 'Side' account' in the FFJ Portfolio.

At the time of my Mid-2022 Investment Holdings Review, BR was my 18th largest holding. When I completed my January 7, 2002 review, it was my 19th largest holding. In mid-April 2021 it was my 22nd largest and in mid-August 2020 it was my 18th largest. Much has changed in the last 1.5 months; I have added to several positions and there has been a considerable change in the share price of several holdings. I am, however, reasonably confident BR is still a top 20 holding.

In recent years, there has been a sizable variance in BR's low/high stock price during a calendar year. I plan to increase my exposure but the surge in BR's share price has led to a valuation that is too rich for my liking.

In several posts in May - July, I mention that we are being presented with a 'window of opportunity' to acquire shares in wonderful companies at reasonable valuations. I cautioned that this 'window' could close in the not too distant future even if there were economic headwinds.

Regrettably, this is what we are witnessing. BR's share price, for example, is now trading at ~$183. That is ~$44.60 higher than my May 9 purchase. Crazy considering the business has not fundamentally changed in under 4 months!

In the short run, the market is a voting machine. In the long run, however, it is a weighing machine. BR's share price could continue to rise in the short term. An event of some magnitude, however, is highly likely to occur at some point at which time I envision BR's valuation becoming more attractive. That is when I want to add to my BR exposure. Not now!

I wish you much success on your journey to financial freedom!

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long BR and ADP.

Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.

I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.