Wednesday, January 21, 2015

Nucleus Software Exports

This is my review of Nucleus software exports from earlier in Jan. 

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Nucleus software is a financial software provider to the banks with a geographically diversified customer base. Currently cash on the balance sheet is worth about 50% of market cap and the stock seems quite cheap. The question really is whether the earnings can be grown.


1. How big is the moat?

Grade: B-


  • Brand replication cost: Brand is decent and the chances of banks hiring a new firm to do their financial software are very low. Customers in this case are likely to be sticky just because of the fear of switching
  • Brand replication timeline: For a new company it will take very long to establish the kind of trust and track record that this company has
  • Ease of product/technology replication: A large software company may be able to replicate this fairly easily but not necessarily make it bug free and something that lots of financial institutions will jump it
  • Sales and distribution replication: This will be highly challenging.
  • Vendor relationships: Nothing really special. Creditor % of sales is fairly large at 19%+.
  • Employee relationships: This is a good area. Average compensation is ~12L/year which is higher than even some of the larger companies. 24L sales per employee which is excellent as well. Not as good as RS software but somewhat better than TCS. Even top management remuneration is only 0.5% of sales which is an excellent sign.
  • Performance during recessions - Will not be great but banks will have to use software as the regulatory environment is forcing them to be highly compliant with esoteric laws - the kind of compliance only a computer can do.
  • Pricing power - Once a long standing customer is established pricing power should be good. Entry level pricing power will be weak.



2. Risks

  • Growth sources - Compliance at banks will be a good driver of growth. Also overall in the developing world banking penetration should rise. In the developed world smaller banks who have not discovered financial software from cheaper and reliable sources like India will be a growth driver. Middle east and Africa business is growing rapidly.
  • Obsolescence risk - Fairly low. Banking transaction and compliance is not likely to become simpler for a long long time.
  • Debt/financial risk - little. There is cash on on the balance sheet which could be squandered away but that is unlikely too.
  • Transparency - Doesnt seem to be a big issue. Reporting is fairly rigorous.
  • Customer creditworthiness - Debtor % of sales is at 11% or so which makes this a fairly moot point. Even so creditworthiness should be decent.
  • Parent company risk - none
  • Long research/product development cycle - not really.


3. Financials

  • FX exposure - Net foreign exchange earner. Given the high inflationary environment in India typically net foreign exchange earner is a good thing. Given that oil is down and the current government is making a massive push for development, FDI, FII and other capital inflows might reverse the decline of the rupee so I am a bit concerned.
  • Options dilution - options were last issued in 2005 and 2006. There are none outstanding at the end of 2014.
  • CFO % of PAT is 78% which is a bummer. Some part can be explained by subsidiary company dividends. Rest of it is from financial instruments that are on the balance sheet.
  • Exceptional items - financial instrument income which contributes 20 Cr to the PBT and 14 to the PAT.
  • Inventories - nothing to talk about.
  • Margins - Minimum in the last 5 years has been 9.4%. Average margins have been 13% but latest margins are 17% which could be a flash in the pan. Latest Q margins are 14.8%
  • Lots of overseas subsidiaries.
  • ROE and ROIC are high at 16% and 65%+ respectively. The ROE is not higher as there is cash on the balance sheet. 

4. Soft factors

  • The stock is a Dolly Khanna holding. She bought and declared in the Mar 2013 filings.At that time the stock was trading between 75 and 80 per share. Which was extremely cheap for this as there was a fair amount of cash on the balance sheet.
  • In the latest quarter ICICI Prudential mutual fund has sold 84K shares or 7% of their stake.
  • Deloitte is the auditor.

5. Pricing

  • After backing out the cash and the return from the non-business related investments the stock is trading at 6.5 times earnings at 200 INR/share. I think around 10% a year of earnings growth can be expected which should generate a decent return over 5 years.
  • There is about 95 INR/share or so of cash & non-business related investments. This could be a good and a bad thing. The company could squander the money or may not be finding opportunities to grow.
BSE: 531209
NSE: NUCLEUS
ISIN: INE096B01018