Protect On The Downside With Broadridge

By Ryan C. Fuhrmann | May 09, 2010 AAA

In early 2007, payroll processor Automatic Data Processing (NYSE: ADP) spun out Broadridge Financial Solutions (NYSE: BR). A weak stock market over the past couple of years has left shares of Broadridge little changed from levels when they first became public. At current levels, the market is not giving Broadridge the credit it deserves for its stable business model and subsequent downside protection. Better yet, recent events could indicate upside potential for shareholders.
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Third Quarter Sales And Profit Trends

Total sales advanced 6% to $490.8 million as new sales offset "weak market conditions (that) impacted trade volumes and stock record growth". Revenue in the flagship investor communications solutions segment, which consists primarily of processing and distributing proxy materials, grew 6.5% and accounted for 72.6% of total sales. Quarterly strength was cited in mutual fund proxy services while bolt-on acquisitions also boosted the top line.

Securities process solutions, which help financial institutions maintain securities transactions records, saw a slight downtick to account for the rest of sales. Broadridge lost a number of clients in this segment and also experienced lower fixed income trade volumes. The firm currently runs a third division, securities clearing, but now considers it a discontinued operation as it will be sold to Penson Worldwide (Nasdaq: PNSN) by the end of its fiscal year. The transaction allows Broadridge the opportunity to jettison a division that wasn't profitable and focus better on its core business.

The Penson deal and a number of other one-time items affected the comparability of year-over-year profit trends. As reported, Broadridge experienced a 39.1% drop in net income to $24.9 million, or 18 cents per diluted share.

Outlook

Broadridge management plans to "achieve higher levels of growth and earnings when market-driven volumes return". It also cited strong sales to new clients, which included the return of brokerage firm Morgan Stanley Smith Barney that was created when Morgan Stanley (NYSE: MS) acquired a majority stake from Citigroup (NYSE: C) at the height of the financial crisis. For the first three quarters of its fiscal year, Broadridge stated that closed sales increased 41%.

Broadridge is currently calling for full-year sales growth between 7% and 9% and earnings from continuing operations between $1.58 and $1.64 per diluted share. Analysts currently expect full-year sales to increase 6.3% to $2.3 billion and earnings per share of $1.59, which would be about flat from last year's bottom-line levels. (For more on analyst expectations, be sure to read Analyst Forecasts Spell Disaster For Some Stocks.)

Bottom Line

The sale of the underperforming securities clearing unit should boost top-line growth and profitability going forward to provide some level of upside potential. The downside is already well protected given Broadridge's customer retention levels (98% so far this year), recurring revenues (80% of sales) and profitability (double-digit net margins). It also boasts a market leadership position in delivering proxy materials and similar securities processes.

Management targets mid-single-digit sales growth and expects to leverage this into higher earnings and cash flow growth over time. At a forward P/E of just over 14, the shares offer a compelling risk/reward tradeoff.

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