Earnings Preview: Total System

Global electronic payment processor and merchant acquirer, Total System Services Inc. (TSS - Analyst Report) is scheduled to release its fourth-quarter 2011 earnings results after the market closes today. Higher operating expenses and sluggish growth in merchant acquiring services amid persistent competitive pressure could continue to mar the desired growth from the bottom-line recovery.

However, improving transaction volume, client growth and the growing presence in high potential markets should bring some buoyancy. Besides, the continuous expansion in the merchant acquiring services, including the recent 100% acquisition of FNMS, along with the subsequent market stability is expected to strengthen its revenue stream.

Previous Quarter Performance

Total System reported third-quarter operating earnings of 30 cents per share, a penny above the Zacks Consensus Estimate of 29 cents and comfortably higher than 23 cents per share in the year-ago quarter. Earnings per share surged 30.4%, while net income attributable to shareholders increased 27.1% to $58.15 million from $45.74 million in the prior-year period.

Results reflect increased revenues from most business segments, lower taxes and increase in overall transaction volume and new accounts. However, continued weakness in merchant acquiring services along with higher-than-expected cost of services and selling, general and administrative (SG&A) expenses partly offset the revenue growth.

Total revenue for the reported quarter was $459.7 million, up 6.1% year over year and exceeded the Zacks Consensus Estimate of $454.0 million. Total number of accounts on file as of September 30, 2011 was 392.4 million, up 15.7% from 339.2 million at the end of the prior-year quarter. The uptick was primarily driven by new client growth and internal growth of existing clients.

Total System reported a 10.6% year-over-year rise in SG&A expenses, which came in at $57.1 million. Alongside, cost of services increased 6.2% year over year to $321.5 million. Meanwhile, operating income climbed 2.9% year over year to $81.2 million in the reported quarter. As of September 30, 2011, year-to-date cash flow from operating activities was $297.7 million, compared with $279.9 million in the year-ago period.

Agreement with Analysts

Ahead of the earnings release, we do not see much variation in analyst estimates over the past 30 days. A similar trend has been noticed over the past 7 days. Hence, the estimate revision trends and the magnitude of such revisions justify no major changes in the sentiment.

In the last 30 days, none of the analysts have revised their estimates upward for the fourth quarter of 2011, although one of the 18 analysts revised its estimate downward. Meanwhile, for 2011, one downward and one upward revision were witnessed in estimates over the last 30 days, overall providing no directional movement. This implies that the analysts have provided a neutral outlook and do not foresee any significant upward or downward pressure on the results.

However, the neutral approach toward Total System also gives scope for some positive surprises in the first half of 2012, particularly, when the continued client growth in 2011 is expected to translate into meaningful top-line expansion.

Moreover, the company is focused on keeping its balance sheet at low risk, a positive that could increase operational efficiencies by deploying capital through share repurchases and dividend payouts. On the other hand, it could also point out the absence of any other major catalyst for growth.

Magnitude of Estimate Revisions

In the last 90 days, there have not been any significant revisions in the earnings estimate following the third quarter results. However, earnings per share upped by a penny to the current level of 31 cents for the fourth quarter. A similar trend is further seen for fiscal 2011, wherein estimates moved up by triple pennies to $1.14 over the past 90 days. Meanwhile, for fiscal 2012, estimated earnings per share rose by a nickel to the current $1.27, over the same period. This trend reveals lack of significant clarity in the analysts’ opinion about Total System.

Surprise

Going by past trends, we have a slightly mixed opinion about Total System exceeding estimates given the company’s raised earnings guidance for 2011 are already factored into the estimates. The company’s reported earnings per share exceeded its expectations for all of the last four quarters and has a positive four-quarter average surprise of 5.42%.

Our Take

Total System has been expanding internationally with announcement of deals in the merchant acquiring and card payment processing space. With TSYS Merchant Solutions (TMS) under its umbrella through the complete acquisition of FNMS in 2011, Total System aims to diversify its portfolio into merchant acquiring and be among the top five merchant acquirers on a global basis in 2-3 years.

Moreover, through share repurchase and the recent dividend increment, Total System continues to return value to shareholders, thereby inculcating confidence for future growth. The company’s efficient capital deployment also reflects its risk-free balance sheet. We expect Total System to benefit from the improving economy and generate healthy cash flow to achieve the raised guidance for 2011 and continue the progress beyond.

However, the company is also vulnerable to increased competition from dominant players such as Global Payments Inc. (GPN - Snapshot Report) and Alliance Data Systems Corp. (ADS - Snapshot Report). Currency and interest rate fluctuations pose additional risks. Finally, we believe that the overall market stability and healthy impact of the regulations in the credit card industry will help in meaningful advancement in client accounts and long-term contracts in the long run.

Hence, we currently provide a long-term Neutral recommendation on Total System, given the equal measure of caution in the intermediate term. Thisalso corresponds to the Zacks #3 Rank, which translates to a short-term Hold rating.

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