Elevator Pitch
My rating for Envestnet (NYSE:ENV) stock is a Buy now.
In my earlier article for Envestnet written on September 12, 2023, I drew attention to the downward revision in the consensus financial projections for ENV, and I also noted the company’s intention to assess its non-core businesses that could be potentially sold in the future.
For the current update, my focus is on the positive developments for ENV which have made me turn bullish on the name. Envestnet’s top line for FY 2024 will be enhanced by new custody revenue, while the company’s bottom line is likely to get a boost from a decrease in expenses. As such, I raise my rating for Envestnet from a Hold to a Buy.
Favorable Expectations Of Lower Costs And Margin Improvement
At the company’s Q3 2023 results call hosted in the earlier part of this month, ENV guided for “$27 million in expense savings” for this fiscal year on the basis that the “investment cycle is complete” and it is “accelerating additional cost reduction measures.”
This explains why Envestnet is expecting the company’s normalized earnings per share or EPS to grow by +7.3% from $1.86 for fiscal 2022 to $1.995 in FY 2023 based on the mid-point of its guidance. As a comparison, ENV anticipates that it will witness flattish top line expansion for FY 2023, as its FY 2023 revenue guidance at $1,239.5 million is marginally lower than the company’s FY 2022 sales of $1,239.8 million.
In other words, a decline in investments and good expense optimization are the main drivers of ENV’s FY 2023 earnings growth. Things are expected to get even better in FY 2024.
Moving ahead, Envestnet’s bottom line will continue to benefit from its ongoing expense reduction initiatives in the next year. As per its management commentary at the most recent quarterly earnings briefing, ENV revealed that it had already achieved “$60 million of run rate savings” now with $27 million already reflected in its 2023 financial numbers, and anticipates that “the remainder of the $60 million (run rate savings) will be recognized next year.”
The positive impact of expense control actions is seen with Envestnet’s EBITDA profitability expectations. Specifically, ENV is targeting to improve its normalized EBITDA margin from 17.8% in FY 2022 to 20.55% and 25% for FY 2023 and FY 2025, respectively. Envestnet also highlighted at its third quarter results call that its EBITDA margin expansion process will be “more of a linear progression” as opposed to “back-end weighted.” This implies that it is highly probable that ENV will have already witnessed significant margin improvement as early as FY 2024, rather than FY 2025.
Custody Is A New Top Line Growth Driver
Previously in late October last year, Envestnet announced that it had entered into a partnership with FNZ to integrate both companies’ platforms so as to offer “digitally automated servicing and maintenance capabilities.” On its website, FNZ claims to have “US$1.5 trillion in assets under administration.”
On November 10, 2022, the WealthManagement.com financial portal run by Informa published an article citing comments from sell-side research firm JMP Securities regarding this development. JMP Securities analysts referred to this FNZ partnership as a key driver of ENV’s custody business which might have double the revenue-to-asset ratio of Envestnet’s existing business.
Envestnet disclosed at the company’s Q3 2023 earnings call that it will begin offering custody services to Registered Investment Advisors and broker-dealers in mid-2024 and end-2024, respectively leveraging on the FNZ collaboration. While ENV didn’t provide any specific quantitative guidance pertaining to the revenue contribution from custody services, the company stated at the recent quarterly call that custody services will be among the businesses that have “a meaningful impact to our P&L (Profit & Loss)” in the “next couple of years.”
Share Price And Valuations
Envestnet’s stock price has pulled back by -21.7% (source: Seeking Alpha price data) since the publication of my prior September 12 article. ENV’s shares are down by -36.1% this year thus far.
ENV’s consensus forward next twelve months’ normalized P/E multiple de-rated from 31.7 times at the beginning of the current year to 17.2 times as of November 20, 2023 as per S&P Capital IQ’s valuation data. As a reference, Envestnet’s 10-year average consensus forward P/E ratio was also higher at 33.4 times.
The sell-side analyst from UBS (UBS) covering Envestnet’s stock, Alex Kramm, pointed out at the Q3 earnings briefing that “the market is obviously not buying in what’s been laid out so far” by the company, and this explains ENV’s valuation multiple compression and share price correction.
In my view, investors haven’t given sufficient credit to Envestnet for the company’s positive developments, which means that a potential re-rating is on the cards.
Concluding Thoughts
ENV is deserving of a Buy rating. Envestnet’s share price weakness and valuation multiple de-rating imply that positive developments haven’t been priced into the stock.
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