Oct 19, 2022 4 min read

EML Payments: Sinking share price ignores the float

EML Payments (EML, $0.69) must be one of the most hated stocks on the ASX. It’s down 88% since its 2021 Covid high but the magnitude of the fall still doesn’t capture it. I’ve never seen a more relentless stream of material and unexpected bad news, nor so many price drops of >20% in a day.

There have been continual and serious issues in their various geographies. There’s been fraud and inappropriate use of customer funds. Regulators have restricted their activities and the longtime CEO recently stepped down without explanation.

Despite this, EML has continued to operate quite profitably, though their statutory results don’t show it. EML would tell you that they’re making $30m a year but I consider something in the region of $10-20m to be a better estimate of their earnings power.

(The detail here is that 1) reversing amortisation of acquired intangibles adds $10-15m a year to profits, 2) it seems reasonable to also assume that most of the $10-15m of annual costs incurred since FY21 due to remediation associated with the Irish Central Bank impositions won’t continue forever and 3) a $16m increase in earn outs in FY21 reflects increased consideration paid for a strongly performing acquisition and doesn’t really belong in the P&L.)

But this writeup is not about forecasting EML’s business results, anticipating a resolution of their issues or evaluating its moat. It’s about EML’s float.

EML provides prepaid cards of various sorts; virtual debit cards, gift cards and the like. What they all have in common is that once cash is loaded onto these cards, it sits in EML’s bank account until it gets spent.

EML had $2bn of such balances and $90m of debt as at FY22 year end. Yet they made just $1.4m of net interest income for a net interest yield of 0.07% on their float less debt. That might seem a little low. While they’ve been receiving a small amount of interest from their GBP cash, they have actually been paying -0.5% on their deposits with the ECB. AUD and USD balances contributed close to nothing, and it all netted out to just about zero.

But $2bn of float will not make zero in FY23.

EML spoke to a $10m per year contribution to operating profits from interest on their float based on their August run rates in their most recent results call. Crucially that did not include any forecast increases in interest rates. EML state (page 17) that they expect to earn about the central bank rate on their float over time.

Even the nowcast based on central bank rates is much higher than that of two months ago. Right now their key rates are:

GBP: 2.25%
Euro: 0.75% (I believe they earn the deposit facility rate)
USD: Not relevant as US float is held by their partner bank
AUD: 2.60%
Weighted average: About 1.7%

Today’s rates would mean a contribution of $35m per year on their $2bn float. Forecast rate rises for the remainder of the year would put their average weighted interest rate north of 2.5% and annual income from their float at over $50m.

This float is valuable. Extremely, unbelievably valuable, and yet nowhere do you see it in EML’s market cap of $260m given it’s earning $10-20m before any meaningful contribution from interest income.

Now, the obvious objection is that the market is looking through the next 1-2 years, is accurately anticipating the inevitable global recession caused by coordinated central bank errors, and is assuming rates fall back to nothing.

That might happen and your downside is owning a growing and capital-light, but scandal-ridden business trading at something like 10x earnings net of the interest income it’ll make before rates go back to zero. Not great, but not terrible either.

If rates do stay high though, even in the 2% range, this stock is worth multiples of today’s price. If inflation becomes entrenched and rates go even higher, a stock like this will be one of the only bright spots amidst the scorched earth of our portfolios.

EML also ticks a few of the boxes that I normally like.

Sentiment is awful and hopes have been dashed. Given the sheer relentlessness of negative news over the past several years, a mere reduction in the frequency and severity of bad news might be enough to turn the stock around. It’s almost impossible for sentiment to get worse, and it’s visible in the stock now barely responding to more recent negative announcements. It’s just not possible for one business to continue to produce bad news so prolifically forever.

This is also a classic career risk stock. You’d be a moron to bet your career on there being no more cockroaches in this business. I fully expect more negative idiosyncratic news, but it’s unlikely to matter.

EML also has confusing factor exposure which might help explain its share price seemingly ignoring its rate exposure. Typically the business trades like a loss-making tech stock, which is indeed how it screens. If ARKK is ever up strongly overnight, you can bet that EML will rip the next day. But the same factors of rising rates and tighter money that are kryptonite for tech exposure are very positive for this business’s fundamentals.

This stock traded for 5x sales only 9 months ago and screens terribly due to the aforementioned statutory losses. There was no reason for a fundamentals-focused investor to look until this year, and only since about July has the price and the interest rate outlook pushed this stock into the strike zone for value investors. It may take some time for the register to turn over.

As usual, the stocks I like have a lot of warts and are not suited to taking concentrated positions, so EML is a small (but growing) position for me at an average price of about $0.75.