IRE

IRESS released a sizeable downgrade yesterday.

Frustratingly, we wrote a note saying that there was clear downgrade risk associated with the recent updates (from July, when the result was pre-released, and from the “clear the decks” phenomenon of a CEO retiring and a new CEO coming aboard).

However, we also wrote that we didn’t have enough conviction to sell out, that guidance was “only” being revised to the low-end of the range, that management transitions (the new CEO) were to be expected given the 20 year tenure of previous management, and that overall commentary on the outlook about the underlying growth rates was good enough, and ambitious enough, and that ultimately we gave it the benefit of the doubt and retained the stock.

That hasn’t worked out well at all. The negative news being drip-fed into the market culminated in yesterday’s update.

However, we will do so again (hold) here. Below is the guidance update.

The current macro backdrop is placing a freeze across a lot of things. Facebook has a hiring freeze; many other tech companies are cutting staff. CarMax, the large US car company, downgraded overnight, citing the impacts of inflation and consumer uncertainty affecting demand (see our separate note here).

While we didn’t really expect IRESS to lead the market in a downgrade in response to these macro trends, believing that the company’s pricing power would put it in good stead against rising costs, and the high level of recurring earnings would insulate it from a decrease in activity, we still expect all of those negatives to be impacting other companies too.

In other words, dumping the stock and running to other names of good value and reasonable quality run a similar risk, exacerbating the problem. That’s thought 1.

Thought 2 harkens back to IRESS’s strong free cashflows. The downgrade is very disappointing, but there’s really no solvency risk whatsoever. They can stop the buyback, if necessary, although if it remains in operation they will be acquiring shares at very attractive prices. That free cashflow is, we think, pretty vital to a) maintaining the thesis and b) attractive relative to other companies that have weaker cashflow profiles.

Thought 3 is the UK exposure for IRESS and the USD’s strength. IRESS does have a sizeable UK presence, which is presently highly challenged. The pound alone will be damaging repatriated earnings into AUD. However, that’s a macro risk rather than an idiosyncratic company execution issue. To be sure, we would have preferred to avoid that macro risk had we foreseen how adversely the market would take the Truss “mini-budget”.

But having not seen it and having endured the impact, we don’t see a good reason to lock in the loss. Politicians come and go. It isn’t clear that Truss can survive the universal condemnation of her program.

The strength of the USD is a problem for just about everyone, everywhere. However, again, we don’t think there’s too much reason to place the blame for cost pressures associated with USD expenses on the company.

Now, to the modest good news that also accompanied the update. They had a sizeable new customer win, a large new client that was one of two in the pipeline. IRESS has guided investors to expect 1-2 sizeable new wins each period, and this one dropped a few months later than expected. Big new clients take time to embed, and this one (Commonwealth Super Corporation) won’t contribute meaningfully until FY23.

Still, the reason for the downgrade is client delays (but they are still winning business) and the global backdrop (outside of their control). So, for now, we will continue to hold in our direct equity portfolios.