Why you should follow Nick Train into Experian

As technology becomes increasingly interwoven into our lives, we are generating huge amounts of data, leaving a digital trail of our habits, preferences and identities. That’s a goldmine of information that businesses can use to target consumers, improve efficiency and assess risk. But unlocking this potential requires the ability to collate and analyse large volumes of raw data – often a time consuming and complicated task. That’s where information services specialist Experian (EXPN) comes in. While its roots lie in credit monitoring, the group has broadened its reach, now providing data and analytical tools to everyone from governments to healthcare providers. It has proved a profitable line of business, generating stable and high margins (see chart), which have translated to a rising return on capital employed (ROCE) – ROCE came in at 16.1 per cent in the year to 31 March 2020, a 0.2 percentage point increase from a year earlier.

We’ve been singing Experian’s praises for a while, last pointing to the growth potential from burgeoning data demand back in March. Since then, the company has attracted the attention of famed ‘buy-and-hold’ investor Nick Train, whose Lindsell Train UK Equity Fund (GB00B18B9X76) recently purchased around 1m Experian shares. Known for his judicious stock-picking, Mr Train adds new holdings to his funds very infrequently, so it’s worth paying attention when he makes a move. In fact, Mr Train wishes he had moved in on Experian earlier, saying “we should’ve owned it years ago”.

That, he says, could have been the case had he listened to his deputy portfolio manager Madeline Wright, a long-standing advocate of Experian’s bull case. Ms Wright likes the ‘give-to-get’ business model whereby lenders supply raw credit history data for free and Experian then aggregates, analyses and sells this back as a credit report. She says the value of this approach lies in “an increasingly rich cache of unique consumer credit data, which is absolutely critical for the decision-making processes of its credit granting customers”. In the world of data, Experian has developed a wide economic moat through the quantity of information it possesses. Regulation is also a barrier to entry although this can sometimes be a mixed blessing – the UK’s Information Commissioner’s Office (ICO) recently demanded Experian improve its data consent practices to limit the unwanted use of personal information for marketing purposes.  

Having amassed the credit history of over 1.3bn people and 163m businesses, it would be difficult for new entrants to replicate this scale. This means the credit reporting industry is a stable oligopoly comprising three major players in the US and UK – Experian, TransUnion (US:TRU) and Equifax (US:EFX). As lenders typically purchase data reports from all three providers, there is little incentive for price competition and because Experian’s services are essential, it enjoys high recurring revenues and customer renewal rates.

Channelling the power of data

Experian doesn’t just sell data, it also supplies accompanying tools to help customers analyse that data. Around 80 per cent of its revenue comes from business-to-business (B2B) activities, which are split across two branches – ‘data’ creates large databases of information, while ‘decisioning’ provides analytics software. “We believe Experian’s datasets will continue to be essential products,” says Ms Wright. “But the shift to decision tools is what will drive substantial growth over the next decade.”

Total B2B revenue reached $4.1bn (£3.1bn) last year, with 9 per cent constant-currency growth driven by newer ‘decisioning’ offerings such as ‘analytics-on-demand’ platform Ascend. Experian invests around 9 per cent of its revenue in capital expenditure, and an increasing proportion of that is being spent on technological innovation. By developing proprietary algorithms, the group can command high margins and the B2B adjusted operating profit margin came in at 30.4 per cent last year.

The margin is comparatively weaker over in Experian’s consumer services division, although still hearty at 23.6 per cent. The group has battled to return consumer services to growth in recent years after rivals introduced free credit checks that undercut its subscription offering. But Experian has now built up its own free service, expanding its membership from just 4m in 2016 to 87m in the first quarter of this year. Profits can be generated from this free audience by up-selling paid products and also generating commissions from ‘credit matching’ – pairing consumers with loans and credit card offers.

Analysts at Morgan Stanley believe consumer services revenue will grow from $1.1bn in 2020 to $1.9bn by 2025. Momentum is expected to be driven by a larger North American membership base and a first-mover advantage in the nascent Brazilian market. Consumer credit penetration in Brazil is much lower with a household debt to disposable income ratio of 52 per cent versus 105 per cent for the US and 141 per cent in the UK. But this will likely change as the country’s middle class expands.

Resilience through the cycle

Experian does have cyclical vulnerability – lending activity typically falls during a recession, meaning there is less need for credit checks. But the group proved resilient during the last global financial crisis, continuing to grow sales organically – albeit in the low single digits – between 2008 and 2010. While the market for new loans was depressed, this was partially offset by counter-cyclical services such as calculating bankruptcy scores and risk management. It also benefited from growth in defensive, non-financial sectors such as telecommunications and utilities. Experian has since expanded its healthcare footprint – where it represents almost two-thirds of all US hospitals – and diverse revenue streams should offer stability through the economic cycle. Broker Shore Capital estimates that credit services now account for less than 30 per cent of total revenue.

Disruption from Covid-19 saw organic revenue fall by 2 per cent year on year in the three months to 30 June. Despite 10 per cent growth in North American consumer services as people looked to improve their credit scores. This was outweighed by a collapse in lending levels in the UK and Ireland and lower credit matching revenue. But conditions are improving. The group had been pointing to flat organic revenue at best in the second quarter, with a possible contraction of up to 5 per cent. But it is now guiding to 3 to 5 per cent growth based on a strong US mortgage market. Most American mortgages are fixed rate, so there is more refinancing when interest rates fall. According to the US Mortgage Bankers Association (MBA), refinancing activity is expected to surge by more than 70 per cent this year before tailing off in 2021. Meanwhile, new housing purchases are forecast to continue growing into next year, which should support demand for credit checks.

Experian’s upgraded expectations bode well for its half-year results, due to be unveiled on 17 November. Analysts at JPMorgan believe that the group’s second-quarter guidance could prove conservative as credit markets in the UK and Brazil recover. Consensus currently places organic revenue growth at 3 per cent for the full year to 31 March 2021 – down from 8 per cent in 2020 – increasing to 7 per cent in 2022.

Following $795m of acquisitions and minority investments, net debt (excluding lease liabilities) stood at $3.9bn at the end of March, up almost a fifth from a year earlier. Equivalent to 2.2 times adjusted cash profits (Ebitda), this is within the group’s 2 to 2.5 times target range.

Higher capital expenditure and slower customer payments due to Covid-19 did knock free cash flow by 15 per cent to $774m in 2020, but prior to that Experian had been generating over $900m of annual free cash flow since 2014. This has underpinned a progressive dividend policy, and unlike many others the group handed shareholders a final dividend earlier this year. While the current $400m share buyback programme has been suspended, Morgan Stanley believes it could be reinstated next year.

Reassuringly expensive 

The main detractor to Experian’s investment case is its lofty valuation. The shares have bounced back strongly from the ‘Corona crunch’ and are now hovering around an all-time high. At 39 times consensus 2021 earnings with an enterprise value-to-operating profit ratio of 30 times, they hardly qualify as ‘cheap’. But we’re inclined to agree with Nick Train on why pricey, high-quality growth stocks can be worth paying up for – he argues that “apparently “expensive” companies with a strategic growth opportunity have often carried on doing well in share price terms.” That’s certainly true of Experian. Excluding a mid-March blip, the valuation has been marching upwards, meaning that those waiting for a more attractive entry point have been disappointed.

This is a long-term, structural growth story based on the increasing importance of data to the global economy. With Covid-19 accelerating digital trends such as online shopping and cashless payments, demand for Experian’s services should increase further. A competitive advantage, diverse customer base and increasing focus on analytics leave it well positioned in the ongoing 'data revolution'.

Last IC View: Buy, 2,844p, 16 Jul 2020