A growth stock with earnings and a strong balance sheet

Junior stock specialist Mike Kachanovsky looks “higher up the food chain”  for a growth stock opportunity that’s got recurring earnings, a strong balance sheet and an outlook for growth. He found an established combination financial stock and technology stock from Europe that has recently entered the U.S. market.

tech_stockGrowth stocks are a good way to play a hot sector and I look for these proverbial high-risk and high-reward stories, but the key is moderation. Tread lightly and do your homework, in other words.

Sometimes it makes more sense to move higher up the food chain and consider a more established player to reduce risk levels. When the situation also involves a strong balance sheet with recurring earnings in tandem with the outlook for growth, it can really pay off. Such is the case I present for Wirecard AG (USOTC—WRCDF), a financial services company specializing in electronic payment transactions and processing.

Wirecard (SWX—WDI) has been trading in Europe since 2005. With a multibillion-dollar market cap and robustly profitable operations, the stock even pays a modest dividend yield.

The company offers a suite of financial products, including its own line of prepaid cards, plus a payment processing system enabling clients to transfer money in payment for online transactions. However, unlike several other companies in the e-commerce financial services universe, Wirecard also operates as its own bank and provides a platform of global banking services linked to more than 200 international payment networks.

As a key advantage to its services, Wirecard provides comprehensive risk management solutions in tandem with its operations. This functions as a profitable business unit itself, but also ensures lower default rates for financial transactions and reduces fraud.

The necessity to mitigate fraud is obvious for any financial endeavor, but when processing online transactions, it is essential to win the trust of end users and partner institutions.

Building on an established European base

The German-based company has consolidated its reach through Europe and is aggressively expanding to other markets in its quest for growth. In 2016, Wirecard established a beachhead in North America, acquiring the Citigroup prepaid card issuer division. This amounts to a lucrative business unit for Wirecard, as prepaid cards generate high operating margins and do not involve credit risk. These cards appeal to people who wish to shop online without using their primary credit cards for the transactions.

Asian expansion underway

The acquisition strategy continued this year, with a recent transaction to purchase a significant client base in Asia from Citigroup. Note that Asian countries still promise the fastest-growing economies in the world.

The deal includes about 20,000 new merchants that will route transactions through its online processing platform. Representing the addition of roughly $20 million of EBITDA (earnings before interest, taxes, depreciation and amortization) in one gulp, this acquisition will also enable further organic expansion opportunities through 2020 and beyond in 11 countries including Singapore, Taiwan, and Indonesia.

African acquisition completed

The company subsequently completed the acquisition of MyGate Communications, to gain access to new clients and financial product lines in Africa. Similar to the Asian opportunity, Wirecard will be able to roll out its own proprietary product line to generate further long-term growth, in addition to the acquired sales channel.

In the near term, Wirecard has provided revenue guidance targeting more than 1.3 billion euros in 2017. This would amount to an increase of about 27 per cent from the prior year. And attractive as the growth rate may be, the operating margins are superb. The company reported gross margins of 49 per cent in the fourth quarter of 2016, an impressive rate of return for any business.

The e-commerce sector is competitive and dynamic, with new products rolling out on a regular basis and tremendous opportunity is at hand for hundreds of millions of new potential clients around the world.

Wirecard shareholders need not tremble at the ambitious targets posted for expansion. The overall market is enormous and the company has been able to capture organic growth as new clients utilize online shopping.

The company builds revenue through transaction fees, cardholder fees, foreign exchange fees and value-added services.

Challenges lie ahead

The challenge going forward for this company will be to continue to deliver on the rapid growth profile, while integrating its key acquisitions, and developing new complementary business units. There are a lot of moving parts to this story and management must remain fully engaged to balance growth objectives while maintaining high profit margins in a competitive and dynamic sector.

For example, one strategy to encourage further growth and customer loyalty is to offer volume-based discounts on its range of financial services. However, to do so would lower the operating margins. In a highly competitive market, if Wirecard does not provide price incentives, it risks losing market share to other established service providers.

Management has opted to focus on expansion in Asia as a means to deliver on its growth objective. In the maturing European market, the gross revenue margins are likely to contract due to competitive pressures, but the opportunity to capture a larger slice of the overall world pie overseas can offset this reality.

Growth will come from established platforms

Financial analysts have estimated that fewer than 10 per cent of all transactions are completed online today. The transition towards online transactions is here to stay and the market acceptance of electronic payments will furnish further growth for many years.

Wirecard is positioned to earn fees on every transaction processed through its network, and continues to add new merchants even as the market itself is growing rapidly.

The company has the advantage of an already established, integrated global presence already. As Wirecard AG expands the reach of its financial services platform to new markets, the trend of strong growth and high earnings margins will continue.

Trading in the range of 55 euros per share, the stock carries a market cap approaching 7 billion euros. Several leading brokerage firms continue to rate the story a ‘buy’, with price targets ranging up to 70 euros.

The entire sector tends to trade on a premium valuation, with an average ratio of 20 times earnings. This is common for a sector where double-digit growth is projected year after year. I believe for an established and profitable success story like Wirecard, there is a lot of upside still in the pipeline. As the company achieves its growth targets, investors may expect higher highs ahead for this stock.

Mike Kachanovsky is a freelance writer who specializes in junior mining stocks and also covers technology companies.

This is an edited version of an article that was originally published for subscribers in the  May 26, 2017, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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