Jack Henry & Associates (JKHY, Financial) is a provider of core information processing solutions for community banks and credit unions. It services 1,100 banks from de novo banks to midtier banks with assets up to $30 billion, 800 credit unions and over 10,000 nonbanking financial institutions. It has a leadership position in what it does; 80% of the revenue is recurring.
Its 10-K reads: Jack Henry & Associates' progress and performance have been guided by the focused work ethic and fundamental ideals fostered by the company’s founders 40 years ago:
- Do the right thing.
- Do whatever it takes.
- Have fun.
Jack Henry has a new CEO, David Fross, who is a long-term veteran of the company. Foss began his career in 1985 at NCR and held leadership positions at Advanced Computer Systems and BancTec. In 1999, he arranged the sale of BancTec's financial solutions division to Jack Henry and subsequently served as president of its Open Systems Group and general manager of the Complementary Solutions Group. He was named general manager of its ProfitStars division in 2006 and president in 2009; under his leadership, ProfitStars evolved from a startup division into what is now a global brand serving more than 10,000 clients in the financial services industry. He was named president of Jack Henry in 2014.
Jack Henry & Associates'Â CEO since 2003, Jack Prim, was appointed executive chairman. Prim joined Jack Henry through the acquisition of Broadway & Seymour's Community Banking Division in 1995. Under his tenure, Jack Henry has seen tremendous growth from 2,800 customers to nearly 11,000 clients and revenue growth from just over $400 million in fiscal 2003 to $1.26 billion in fiscal 2015
Financial profile
Jack Henry broke down segments by customer type (bank and credit union) and by revenue model (licensing, support and service and hardware sales). But over the years support and service has grown to 96% of the revenue and 97% of the gross profit with two other revenue sources becoming immaterial. Here we only discuss the segments by customer type.
The Bank segment, Jack Henry Banking, is a leading provider of integrated data processing systems to over 1,100 banks with assets up to $30 billion. The banking solutions support both in-house and outsourced operating environments with three distinct core processing platforms and more than 100 integrated complementary solutions.
The Credit Union segment, Symitar, is a leading provider of core data processing solutions for credit unions of all sizes, with over 800 credit union customers. Symitar markets two functionally distinct core processing platforms and more than 50 integrated complementary solutions that support both in-house and outsourced operating environments.
Jack Henry has the third brand/subsidiary, ProfitStar, a leading provider of highly specialized products and services to financial institutions that are primarily not core customers of the company. Jack Henry does not break out ProfitStar’s numbers as a separate segment, but it has given enough space in the company 10-K to indicate that could be the long-term growth engine of the company. Note the new CEO has built this division almost from the ground up.
Jack Henry’s revenue has been growing both organically and through acquisitions. The company’s made 29 acquisitions since June 1999. The biggest cluster of acquisitions happened in 2010 right after the financial crisis. In both periods of organic and inorganic growth, Jack Henry maintained high ROIC and enjoyed margin expansion. This demonstrated Jack Henry’s strong operational, financial and integration expertise. The ROIC has been materially lifted since 2010 since the biggest batch of acquisitions.
Jack Henry feels it has few gaps in the product line and few acquisition opportunities to expand or enter new markets. In addition, the market is expensive. Therefore, although constantly looking, it would likely allocate excess capital to dividends and share buybacks. It currently pays a 1.2% dividend yield with payout ratio of 33%. Since 2013, the company has shrunk its share base by over 8%. At this point, we should expect that the growth would largely be organic.
Source: company filings
Source: GuruFocus.com
We estimate the revenue growth to be mid- to high single digits on an organic basis. According to FDIC data, over the last 19 years, total assets of small banks grew 7% per year. This could be a good indicator of Jack Henry’s top-line growth. In fact, the correlation between growth of Jack Henry’s revenue and bank credits at small banks is 97%. Jack Henry’s revenue is defensive. In fiscal years 2009 and 2010 ending in June, the worst of the financial crisis, Jack Henry still had 6% and 8% organic growth in the support and services segments, which now accounts for 96% of the total revenue.
Jack Henry’s revenue growth is higher in the inorganic expansion period but has been in line with small bank credit's growth after the acquisition phase largely ended in 2010. As the interest rate cycle starts to turn, the banks will enjoy rising profitability and could have more spare money to spend. In addition, new bank services powered by computers could lift the growth even higher. Jack Henry is also slowly taking market share from competitors. Therefore double-digit revenue growth would not completely surprise us in the next five years.
Source: FDIC data and GuruFocus.com
We estimate that the net income growth will be about 10%, two to three percentage points higher than top-line growth. It appears there is some operating leverage in the business (see chart below). Given that bank assets will likely continue to grow and banks margins will likely go up, Jack Henry could continue to enjoy margin expansion in this up cycle.
Source: GuruFocus.com
At current price, share repurchases would lift EPS growth 2.5%. Jack Henry has been spending $175 million on stock repurchases. At a $90 stock price, the share base would shrink 2.5% a year.
All in all, 7% to 10% top-line and 10% to 15% EPS growth is very achievable. For 2017, management guided 5% to 6% growth, or 3.04 to 3.06 EPS, which includes 5% negative impacts or one-offs on comparable basis. Street estimated EPS at $3.11. The company beat consensus by a large margin for at least the last four quarters. Therefore it is likely that the management tends to give conservative guidance. As a result, we feel comfortable with our growth estimates.
Jack Henry has leading positions in the small banks and credit unions space. Its major competitors are Fidelity National Information Services (FIS, Financial) and Fiserv (FISV, Financial), whose clients tend to be larger than Jack Henry’s. Both have higher leverages and inferior returns.
Source: GuruFocus.com
Why the stock is likely a long-term outperformer
There are not many businesses that have wide moats. Jack Henry is one of the few. Its services and products are crucial to the clients’ core operations. Switching costs are high. Revenues are recurring. These ensure continued high margins and ROIC.
The management has a proven track record at growing the company both organically and through well-timed acquisitions. When there are no acquisition opportunities, the excess cash is used on share buybacks and dividends as demonstrated in the chart below.
Source: GuruFocus.com
Risks
The new CEO may not be able to man the ship as well as the previous CEO. But this risk is mitigated by the fact that the strong ex-CEO is elevated to executive chairman and the new CEO is a long-term veteran with the company.
Valuation is by no means cheap no matter how we look at it.
Valuation
Management guided $3.04 to $3.05 EPS per share for fiscal year 2017 (ending in June). Consensus is at $3.11. Forward P/E is 29x for a 10% to 15% organic EPS growth business. Like the market, the valuation is at the highest in years. Historically Jack Henry has been priced at a premium to the market in normal business cycles. Adjusted for the gain on sale of a business in 2016, the current trailing P/E is about the same premium relative to the market as before.
The stock deserves a premium due to consistent earnings profile, strong returns on capital, recurring revenue and proven strong management. But the price looks fair relative to the market; the new CEO still needs to prove that he can man the ship just as well. A journey to 20x or $60 would provide a better entry point. Or alternatively, you could hedge with shorting ETF of, say, iShares Russell 2000 (IWM, Financial). However this would give up on dividends as Jack Henry has a 1.2% dividend yield and Russell 2000 has 1.4%.
Source: GuruFocus.com, multpl.com
Relative to peers, Jack Henry has a valuation premium, but the premium is warranted due to strong profit margin, consistency in earnings and strong management.
Source: GuruFocus.com
Disclosure:Â We don't have positions in Jack Henry.
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