Today I’m going to look at two stocks that have delivered serious gains for investors over the last few years. Both have faced questions about the quality of their earnings, but both have continued to deliver solid, cash-backed growth.
Both stocks remain potential buys in my view, but do the possible rewards outweigh the risks?
Payment winner
Payment processing company Paysafe Group (LSE: PAYS) saw revenue rise by 63% to $1,000.3m last year. The firm’s adjusted pre-tax profit rose by 96% to $213m. These figures were boosted by shifting exchange rates, but even without this tailwind Paysafe’s revenue would have risen by 21%.
Formerly known as Optimal Payments, the company rebranded after its bold $1.2bn acquisition of US rival Skrill in 2015. I have to admit that I’ve been unsure about the durability of this firm’s earnings in the past. Online gambling accounts for almost half of revenue, creating regulatory risks that are hard to measure.
Paysafe’s 2016 results suggest I may have missed an opportunity. The figures show strong organic profit growth that’s backed by free cash flow. Excluding acquisitions, Paysafe’s free cash flow was $208m in 2016, slightly more than the group’s $194m operating profit. Some of this surplus cash was used to reduce net debt, which fell from $431m to $279m last year.
The company is also taking steps to reassure investors concerned about corporate governance risks. Since joining the FTSE 250 last year, Paysafe has appointed a new auditor — Deloitte — and added two additional non-executive directors to its board.
It expects to achieve “low double-digit organic revenue growth” in 2017, with an adjusted EBITDA margin of at least 30%. This puts the stock on a forecast P/E of 10.6, which looks about right to me, given the lack of a dividend. I’d hold.
A valuable service
One of the biggest costs facing anyone operating an online business is customer acquisition. This is especially a problem in sectors such as online gambling, where churn rates can be high.
AIM-listed XLMedia (LSE: XLM) has built a very profitable business by generating leads and finding new customers for online brands. Revenue rose by 16% to $103.6m last year, while pre-tax profit rose by 28% to $31m, giving a pre-tax profit margin of 30%.
The group’s impressive profit margins are partly a result of its payment terms with major online casino operators. Rather than being paid a one-off sign-up fee for each new customer, XLMedia is often paid a percentage of the lifetime revenue from each player’s activity.
Online gambling is still its largest vertical and accounted for 70% of revenue last year. But this figure is down from 83% in 2014. The group is diversifying. For example, it recently acquired a credit card price comparison business in Canada.
I’d hesitate to pay too much for the shares. But the firm’s profits are backed by strong cash generation. XLMedia paid dividends totalling 7.6069 cents per share last year, giving a trailing yield of 5.6%. The group has no debt and net cash of $33m.
Its shares currently trade on a 2017 forecast P/E of 10.7, with a prospective yield of 5%. I’d remain a buyer at current levels.