The key to successful investing outcomes is to find great businesses that are trading at discounts to their fair value. This week three companies reported earnings which are currently screening as undervalued and have a wide or narrow moat rating from our analysts which indicate a sustainable competitive advantage.

PSC Insurance Group Ltd (ASX: PSI)

PSC Insurance is an intermediary between small and large companies and insurers, enjoying a high level of recurring revenue given sticky customer relationships and insurance essentially seen as a necessity. Primarily operating in Australia, New Zealand, and the U.K. PSC owns broker and underwriting businesses, and runs a network for independent brokers to access the benefits of being part of a larger group.

PSC Insurance reported a solid first-half fiscal 2024 result and modestly increased full-year guidance. While 12% earnings before interest, taxes, depreciation, and amortisation (“EBITDA”) growth is strong, premium rate increases and acquisitions help mask weakness in the United Kingdom.

It has been all one-way with premiums for several years, but softer market conditions in cyber and mergers and acquisitions insurance lines kept UK earnings relatively flat. Encouragingly, management noted signs of a recovery with the recent decline reflective of market activity. Less demand results in premium rates falling, and operating leverage for an insurance broking business hurts on the way down.

Narrow-moat PSC being diverse across regions and products helps offset weakness and, in particular, the insurance line. There could be a silver lining in the fact that more challenging times bring a renewed focus on discipline, both in chasing new customers and servicing existing customers.

We reiterate our $5.20 fair value estimate. We don’t think double-digit premium rate increases will be maintained, but see moderate increases as insurer profitability is not excessive. While pockets of downward rate pressure could appear, we do not expect this to be a trend given inflationary pressures and an increasing frequency and cost of large natural hazard events. Acquisitions remain an important pillar of PSC's growth, with $150 million in firepower. Growth in the first half was split 40/60 organic and acquired.

Group margins slipped 1.25% to a still-respectable 34.1%. but we forecast a bounceback in the second half to match fiscal 2023 margins of 37%, and trend closer to 39% by fiscal 2028. We expect modest gains in already high-margin broking and agency businesses, and UK margins to recover as premiums recover and PSC keeps expense growth down.
Our prior fiscal 2024 EBITDA forecast sat above guidance, and is increased modestly to $129 million, the 16% growth at the top-end of management guidance.

Dominos Pizza Enterprises (ASX: DMP)

 

Domino's Pizza Enterprises is the Australian master licence holder of the Domino's Pizza brand. It also has operations in New Zealand, Japan, Singapore, Malaysia, France, Germany, Belgium, Luxembourg, Taiwan, and the Netherlands. The stock suits investors seeking exposure to the food and beverage sector. Management is active, importing marketing strategies from the United States, or creating new ones, and applying them to local trends in individual markets. Management has adapted to market trends by refreshing the product range, including healthier ingredients and gourmet styles, and transitioning to online ordering.

Narrow-moat Domino’s recent global same-store sales growth is encouraging. In Australia and New Zealand, and Germany, sales growth continues to be robust in the first seven weeks of the second half of fiscal 2024. In Asia, sales momentum is improving, with the largest market in the region, Japan, growing same-store sales at a solid mid-single-digit clip.
However, same-store sales are declining slightly in Europe, with France dragging down the regional performance. Management intends to adopt successful strategies—that have been proven in Australia and Germany—in these underperforming markets.

We anticipate these improvements to only gradually convert into stronger sales momentum. We expect it to take until fiscal 2025 for global same-store sales growth to recover to our long-term mid-single-digit forecast. In France, the challenge is to garner franchisee support for an aligned marketing and pricing approach, while the relatively low order frequency in Japan slows the feedback loop of changes to management.

Same-store sales are a key driver of franchisee profitability, which in turn drives Domino’s store rollout and network sales trajectory. Franchisee profitability has softened considerably since the pandemic. We estimate average rolling 12-month EBITDA per store decline by 40% to September 2023, since reaching boom-time highs in March 2021.

We believe the current same-store sales slump in Europe and diminished average store profits don’t affect Domino’s long-term growth runway and the longer-term rollout targets stand. Management concedes the timing of reaching its target of 7,100 stores by fiscal 2033 depends on franchisee profitability. We maintain our more cautious midcycle store network forecast of some 6,300, compared with roughly 3,800 in fiscal 2023. Our $61 fair value estimate is unchanged and shares screen as significantly undervalued.

FINEOS Corp Holdings (ASX: FCL)

 

Fineos is a core software vendor to the global life, accident, and health, or LA&H, insurance industry. Customers are primarily large multinationals and midmarket insurers. The firm generates revenue mainly from subscriptions and product implementation services. About 75% of revenue is generated from the U.S., the rest from the Asia-Pacific and Europe.

Fineos help insurers streamline workflow, save costs, and win new business. Benefits of Fineos’ products to insurers include automating/unifying work processes, centralizing data, reducing the time to market for new products, and enabling greater user interface, assisting business wins and client retention. Fineos is currently migrating customers to a cloud-based offering (from on-premise products). This makes it easier to roll out new features and support at lower marginal costs, while also providing more recurring subscription revenue.

Progression toward profitability is reaffirmed by wide-moat Fineos’ 2023 earnings. Operating losses have narrowed as earnings before interest and taxes (“EBIT”) margins improved. EBITDA was positive at around 5 million Euros in the second half, from a loss of around 3 million Euros in the prior comparable period.

This is being supported by both increased gross profit margins from the transition to cloud-based products and cost-saving initiatives, including lower research and development costs. Software revenue grew by the high single digits, mainly from greater product uptake among existing customers, highlighting demand inelasticity despite cost-cutting. Fineos anticipates both revenue growth and reduced operating costs in 2024, suggesting further margin expansion.

We retain our fair value estimate of $3.10 and believe shares are undervalued. We expect Fineos to be free cash flow positive in 2025 and net profit after tax profitable around 2026, with operating margins expanding to the midteens by 2033. EBITDA margin was 8.1% in 2023.

Expenses are likely to reduce as a proportion of revenue, relative to 2023’s levels. Fineos continues to lower its nonessential costs, which contributes to its lower cost outlook for 2024. Critically, growth in foundational product development spending is slowing, as Fineos has completed its product implementation work with certain large clients. This means the firm is now in a better position to expand margins, because the same product set can be deployed across various clients with similar requirements without the need for substantial customization costs.

Product up/cross-selling, new customer wins, and expansion into adjacent markets should support revenue growth averaging 10% per year through to 2033. Notably, New York Life—Fineos’ largest client—will expand its usage of Fineos across other business lines, which strengthens switching costs.

Want to learn more about investing in shares? Learn how to identify companies with sustainable competitive advantages and how business risk should be considered when buying shares.