JKHY - Jack Henry & Associates: Positioned For Accretive Integrated Growth

2023-05-26 15:57:51 ET

Summary

• Over the past year, Jack Henry & Associates, Inc. has trailed both the S&P 500 Index and TradingView's financial technology index.
• This comes in spite of 2021-22 free cash flow growth of 7.02% in addition to scale growth supporting a 10.50% increase in total revenues to $1.94bn.
• Broadly, divergent financial reality and share price action reflects shareholder hesitancy regarding potential demand compression for Jack Henry's services in a recessionary environment.
• Through its financial situation and ability to execute M&A while accelerating whole business integration, Jack Henry has demonstrated the operational capability to sidestep macro headwinds.
• The combination of Jack Henry's undervaluation and operational strengths leads me to rate the company a "Buy."

Jack Henry & Associates, Inc. ( JKHY ) is a Missouri-based financial technology and payment processing company with operations across the U.S. Serving over 7,800 customers, Jack Henry is comprised of three primary brands; Jack Henry Banking, which provides integrated computer systems for banks; Symitar, which offers similar services to credit unions; and ProfitStars, a core-agnostic solutions provider to both banks and credit unions.

Through its actions and by prioritizing the client, employees, and shareholders above all others, Jack Henry & Associates, Inc. has experienced a broad-based presence throughout the U.S., penetrating nearly all regional financial institutions and with a majority of clients using Jack Henry's private cloud products.

Introduction

Jack Henry centers its value proposition around six primary drivers; its corporate culture, which supports reduced attrition and productivity; the sheer market size it operates within and anticipated macro growth factors; the inherent moat perpetuated by the learned infrastructure the company offers; its fortress financial position; strong capital deployment emphasizing shareholder returns alongside inorganic and organic investment; and positioning the company for capturing maximized growth through the latter means.

Jack Henry's focus on securing its future market position has led to a fivefold strategy for the future, involving a concentration on enhanced core offerings, incorporating future technologies for optimized organization, promoting customer engagement, continuing the company's tradition of open banking, and a concerted M&A strategy for incremental operational capacity growth.

Valuation & Financials

General Overview

In the TTM period, Jack Henry- down 19.58%- has trailed both the broad market, represented by the S&P 500 ( SPY )- up 4.06%- and the Financial Technology Index developed by TradingView- up 11.40%.

While the fintech industry at large has been impacted by rising interest rates and the fallout of successive bank crises, Jack Henry maintains an outsized relationship with banks and credit unions, as such bearing the brunt of these macro events.

However, I believe the market is overreacting, since, as the growth in Jack Henry's cash flows and revenues illustrate, the company has successfully navigated these headwinds.

Comparable Companies

Among the advantages Jack Henry sustains is its differentiated business model- this also means that the firm contends with less direct competition. That said, companies like the restaurant-centric payments platform Toast, Inc. ( TOST ) or commerce solutions platform Shift 4 or B2B platform WEX Inc. ( WEX ) are of comparable sizes and operate in similar verticals.

As demonstrated above, Jack Henry has experienced the poorest yearly and second-poorest quarterly price action.

And while the company maintains a high P/E multiple, its other financial metrics run counter to market sentiment of the firm; for instance, Jack Henry sustains the lowest debt/equity ratio- enabling more significant long-term reinvestment- in addition to the second-best ROE and best ROA.

Moreover, the second-best 5-year revenue and earnings growth the company experienced in spite of already enjoying the best profitability amongst peers is a further reason for long-term bullishness.

Valuation

According to my discounted cash flow analysis, the fair value of Jack Henry, at its base case, is $180.81, up from its current price of $148.31, meaning the company is currently undervalued by 18%.

My model, calculated over a 5-year period without perpetual growth, assumes a discount rate of 8%, incorporating the excess risk in the financial services industry while accounting for Jack Henry's debt-light cap structure. Furthermore, although the company has experienced an average CAGR of 7.5% over the past three years across all three verticals, I assume a more conservative growth rate of ~5%.

My thesis on undervaluation is corroborated by AlphaSpread's multiples-based valuation tool, which calculated that Jack Henry is undervalued by 10%, with a fair value of $163.90.

Thus, taking an average of my discounted cash flow ("DCF") analysis and AlphaSpread's relative valuation, the true value of Jack Henry should be $172.36, meaning the company is currently undervalued by ~14%.

A Combination of Organic Growth & Disciplined Capital Allocation Ensures Shareholder Satisfaction

Via its mix of acquisitions and enhanced consumer engagement, Jack Henry & Associates, Inc. has set forth a vision for how it will be ingrained in U.S. financial infrastructure. The company seeks to implement updates and provide products on a selective basis, interchangeable between different financial institutions. Additionally, Jack Henry seeks for these components to be able to directly connect with any other Jack Henry product. Beyond further promoting a 'walled garden' of sorts of the company's services, this can enable upselling and greater accessibility, with firms that may otherwise not use Jack Henry engaging with the company.

Such front-facing integration is mirrored by the company's intra-organizational effort to synergistically consolidate. Jack Henry seeks to optimize its expense structure and enable superior sales and unified product-design capability through this. To ultimately achieve this target of organizational integration, the firm will apply four principles, including greater transparency, consistent decision-making processes, greater direct collaboration, and supporting different communication between verticals.

While different levels of integration support reduced cost and augmented profitability, Jack Henry supports maximized shareholder return through its capital deployment strategy. With an impressive 20.1% ROIC, the company is able to commit more capital towards its stable dividend and opportunistic share repurchases. The rest of the firm's cash flows are directed towards reinvestment or M&A, which support continued returns and growth.

Wall Street Consensus

Analysts support my largely positive view on Jack Henry, estimating an average one-year price increase of 15.20% to a price of $170.86.

Even at the minimum projected price, a -3.30% decline to $143.42 is a fairly modest dip in the face of the risks facing the financial services industry.

Risks & Challenges

Continued Interest Rate Pressure

Rising interest rates have led to asset value declines in financial services firms' balance sheets, consequently leading to compressed demand for Jack Henry's products, which primarily cater to banks and credit unions. Any continuation or acceleration of this trend may further depress demand and reduce Jack Henry's ability to scale and generate cash flows.

Accelerated Competitive Intensity

Although the firm operates in a fairly niche and specialized vertical, there remains the risk of backwards integration on the part of clients. This especially pertains to larger banks, who may then offer services to local banks and credit unions, who encompass Jack Henry's primary market. Successful attempts to do so would hamper Jack Henry's value proposition and market position.

Multi-Party, Macro Risk

As demonstrated by the bank crises of the past few months, the financial industry remains one inherently intertwined with third-party activities; extending to Jack Henry, regional banks, hit the hardest by these bank crises, saw reduced liquidity, profitability, and purchases of Jack Henry products. While innovations such as component purchases of Jack Henry services may absorb these sorts of impacts going forward, the company's capabilities and demand may still be harmed.

Conclusion

In the short term, I expect Jack Henry & Associates, Inc. stock to revert to its fair value and recover from bank crises and interest pressures of late.

In the long term, Jack Henry & Associates, Inc.'s component-centric strategy and integration - alongside potential acquisitions - will support accretive, enduring growth.

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