Still Neutral on Total System - Analyst Blog

We reiterated our Neutral recommendation on Total System Services Inc. ( TSS ), the global electronic payment processor and merchant acquirer, based on the current sustainability factor. The company reported third-quarter operating earnings of 30 cents per share, a penny higher than the Zacks Consensus Estimate but comfortably higher than 23 cents per share in the year-ago quarter.

Results reflected 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.

Moreover, Total System is vulnerable to increased competition from dominant players such as Global Payments Inc. ( GPN ) and Equifax Inc. ( EFX ). The company has significantly high backlog of accounts. Despite the upside, management's outlook for bottom-line growth in 2011 still appears stressful, as the earnings per share is primarily based on a lower share count. With weak internal fundamentals, the company is liable to lose edge over its competitors going ahead.

Moreover, despite the economic recuperation since 2008, operating margin has witnessed a decline from 28.6% in 2008 to 27.2% in 2009 to 25.6% in 2010. It further declined to 17.4% in the first nine months of 2011 from 18.7% in the same period of 2010.

Margins include the impact of deconverted portfolios as the result of bank failures and portfolio sales, price compression, reduction in one-time termination fees and currency impact along with the continued tepidity in the credit card market. Alongside, currency and interest rate fluctuations pose additional risks. Going forward, any unfavourable impact of regulations could hamper the company's inorganic growth strategy.

On the flip side, Total System has come a long way from the negative top-line growth trend. Since the second quarter of 2010, the company's fundamentals are screening decent growth in the top line. Although the rate is stuck at lower single digits, the company's growth drivers lay ample optimism on the performance of the stock in the long run.

The market recovery has also enabled the improvement in new client growth, same-client transaction volumes and accounts-on-file. Going ahead, the revenue recovery is believed to follow slow and steady growth in North America as well with the company's leading technology platform, steady long-term contracts, improved pricing and healthy consumer spending once the economy stabilizes.

Total System's risk-free balance sheet along with a modest cash position and cash flow generation provides viable scope for share repurchases and acquisitions. Particularly, the recent expansion of share repurchase program continues to inculcate confidence among investors.

Finally, we believe that the overall market stability and healthy impact of the regulations in the card industry will help recover the number of client accounts and long-term contracts, thereby reflecting an upside potential in the long run.

Given the pros and cons, the Zacks Consensus Estimate for the fourth quarter is pegged at 31 cents per share, increasing about 30% over the prior-year period. For 2011, earnings are expected to rise 27% over 2010 to $1.14 per share.

Additionally, the quantitative Zacks Rank for Total System is currently #2, indicating a slight upward pressure on the shares over the near term.

EQUIFAX INC ( EFX ): Free Stock Analysis Report

GLOBAL PAYMENTS ( GPN ): Free Stock Analysis Report

TOTAL SYS SVC ( TSS ): Free Stock Analysis Report

Zacks Investment Research

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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