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Total System Kept at Neutral

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We are reiterating our Neutral recommendation on Total System Services Inc. (TSS - Free Report) based on the current sustainability factor. Although the company has been witnessing improvement over the past few quarters, risks related to operating leverage remain at the forefront.

Total System reported first-quarter 2012 operating earnings of 30 cents per share, in line with the Zacks Consensus Estimate but a nickel higher than the year-ago quarter. Consequently, net income increased 15.6% to $56.4 million from $48.8 million in the prior-year period.

Results reflect consistent growth in revenues across all business segments and increase in overall transaction volume and new accounts. However, higher-than-expected cost of services and selling, general and administrative (SG&A) expenses, along with higher taxes, partly offset revenue growth.

After a series of revenue contraction during the peak of financial crisis, Total System has swung to revenue growth since the second quarter of 2010, following which revenue rose by 5.3% year over year in 2011, from 2.4% year over year in 2010 and a contraction of 2.0% in 2009. Revenues further grew 7.4% year over year in the first quarter of 2012, thereby reflecting modest improvement in accounts on file, transaction volumes and spike in total acquiring services and its long-term contract portfolio.

We believe the company is further expected to benefit from its leading technology platform, improved pricing and healthy consumer spending once the economy stabilizes to normal levels. The slow but steady growth momentum is also validated by management’s buoyant earnings outlook for 2012.

Moreover, Total System’s risk-free balance sheet along with a modest cash position and cash flow generation provide a viable scope for share repurchases and acquisitions.

Also, its pipeline of international opportunities should help stimulate above-average growth. Alongside, the company poses a healthy current ratio, thereby appearing well-equipped to meet most of its capital expenditure needs through internal funds.

On the flip side, though, Total System’s anticipated growth is being marred by a higher backlog of accounts, coupled with increased risk from interest rate volatility and foreign currency fluctuations.

Additionally, Total System faces intense competition from data processing, bankcard computer service firms and third-party software vendors within the U.S. as well as from international processors and third-party software vendors. The company’s prime competitors include Equifax Inc. (EFX - Free Report) and Wright Express Corp. , while it also faces operating challenges from MasterCard Inc. (MA - Free Report) , Visa Inc. (V - Free Report) and Discover Financial Services (DFS - Free Report) .

This implies that Total System has a very dynamic and strong peer group that competes on various crucial operational factors such as price, system performance and reliability, versatility of features, functionality, disaster recovery capabilities, business continuity preparedness and data security. Amid volatile macro-economic factors, regulatory challenges and sluggish fundamentals, the company must fight to keep its edge over its competitors going forward.

Based on all the pros and cons, the Zacks Consensus Estimate currently pegs earnings at 32 cents for the second quarter of 2012, up about 13% year-over-year. For 2012, earnings are projected to increase to $1.29 per share. This reflects an increase of about 12% year over year, which is in line with the upper end of management’s guidance of 10–12% growth for 2012. Currently, Total System carries a Zacks Rank #3, which translates into a short-term Hold rating and long-term Neutral recommendation.

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