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High Debt Puts Total System Under Scrutiny

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On Feb 28, we issued an updated research report on Total System Services Inc. (TSS - Free Report) . Although the past and recent acquisitions have helped the company reach the $2.0 billion mark in revenues in 2013, higher debt-levels on account of these acquisitions are expected to mar the desired upside in the near term.

Moreover, Total System has delivered negative earnings surprise in 2 of the last 4 quarters with an average beat of 0.02%. The company’s fourth-quarter earnings were in line with the Zacks Consensus Estimate but beat the year-ago quarter number by 40%.

Meanwhile, the acquisition of NetSpend in Jul 2013 has made Total System the 2nd largest program manager of dollars reloaded in prepaid cards as per the Mercator Advisory Group, thereby enhancing its footprint in the U.S. prepaid card industry and bolstering long-term growth through a diversified portfolio.

While the NetSpend acquisition is expected to be accretive to earnings within its first year, ending Jun 2014, it also validates the company’s bright top-line guidance in the band of 17–19% in 2014 and adjusted EBITDA within 17–20%, both up from the 2013 equivalent levels.

However, the cash outlays on acquisitions and technological developments have taken a toll on a healthy cash flow growth trend. Adverse asset-liability changes as well as acquisitions and software purchase payments resulted in deteriorated operating cash flow in 2013.

Subsequently, expected higher debt obligations, expense flow, operating margin reduction and minimal synergies from NetSpend in 2014 make us wary about cash flow growth and healthy capital deployment in the upcoming quarters. Simultaneously, increased competition, regulatory challenges and exposure to interest rate and foreign exchange volatility raise our concern.

An adverse risk-reward balance in the near term led to negative estimate revisions for 2014. Seven out of eight estimates for 2014 were revised downward over the past 30 days with no upward revision. This led to a significant decrease of 12 cents in the Zacks Consensus Estimate for 2014, which now stands at $1.80 per share.

Key Picks in the Sector

While Total System carries a Zacks Rank #4 (Sell), some better-ranked stocks in the financial sector include Verifone Systems Inc. (PAY - Free Report) , Global Payments Inc. (GPN - Free Report) and Euronet Worldwide Inc. (EEFT - Free Report) . All these stocks bear a Zacks Rank #2 (Buy).

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