DST Systems, Inc (NYSE:DST) is a global provider of technology-based service solutions that help process, communicate and safeguard important customer information for asset managers, telecom companies and insurance and healthcare providers. The stock has performed well over the past six months, as has the general IT services group, and analysts expect it to continue to do so. Both analysts at Zacks Investment Research who cover the stock gave it a strong buy recommendation and set a 12-month consensus price target of $118.00. Separately, the First Call Corporation also upgraded DST to a consensus strong buy rating. In this report, we'll take a look at the different factors that make this stock so attractive to rating agencies, and why we are also bullish on DST.
Before we begin our analysis, investors should know a little about our analytical style. Our analysis focuses on identifying and exploiting stock market "anomalies." We've identified a variety of different academically tested metrics that have a long track record (over 50 years) of predicting stock returns. We'll provide links to the academic papers that fuel our analysis as we progress through the report so you can see for yourself whether to trust the metrics we rely on. Click here to see a detailed breakdown of the prominent academics (many of whom manage billions of dollars) and their contributions to the field of stock research that we draw inspiration from.
Valuation breakdown
We'll start with an analysis of DST's valuation profile, looking at five valuation metrics each with a strong predictive ability. This is important to consider as Nobel laureate Eugene Fama showed that "value stocks have higher average returns than growth stocks." The "value" anomaly is the strongest and most consistent edge in the market, as study after study has shown that cheap stocks beat expensive stocks. DST's valuation profile is shown below:
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The most obvious indicator of DST's value is its earnings yield (inverse of P/E). At 13.91%, DST has the highest earnings yield of all 65 stocks in the IT services group, third highest of the 520 stocks in the Information Technology sector and is in the 96th percentile of all stocks in the market. This amazing earnings yield is most likely why Zacks "Style Score for Value" is an A. The other main driver of value for DST is its sales yield of 69.44%. This is over 88% higher than its sector average and nearly 40% higher than the market average of 50%. On a price-to-book basis, DST is expensive relative to the market but relatively cheap in comparison to other stocks in its group and appropriately valued relative to its sector. There's nothing particularly noteworthy about its free cash flow value and, similar to most stocks in its group, it doesn't offer much of a dividend. Thanks in large part to its incredible earnings yield, we see DST as moderately undervalued and predict that it will beat the S&P 500 over the next 12 months due to its value profile.
Growth breakdown
There is a variety of different growth metrics that have been shown to predict stock returns. Most important among them is price momentum. Winning stocks keep winning (based on six-month price performance), and losing stocks keep losing. As outlined in James O'Shaughnessy's book What Works on Wall Street, EPS growth and return on equity/assets also were shown to have predictive ability, albeit to a lesser extent. DST's growth breakdown is shown below:
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Even with its strong momentum, 23.68% gain in the last six months and 13.21% gain over the past 12, DST's strongest growth indicators are its EPS Growth and returns on equity and assets. With annual diluted net earnings per share (EPS) growing from $8.00 in 2013 to $14.66 in 2014, DST's EPS growth of 83.10% is higher than 87% of its group and well above the market average of 10.10%. With an ROE of 49.6% and an ROA of 19.9%, DST is in the top 5 percent of all stocks in the market for both metrics. Its ROE and ROA are both over three times its group average and over five times the market average. Based on these growth metrics, we foresee substantial future growth for DST and expect the stock to outperform over the next 12 months as a result.
Earnings
Next, we'll see how DST has been performing relative to analyst expectations recently. We've found through historical backtesting that stocks that have a history of beating analyst expectations are much more likely to beat estimates in the future. We've used this earnings model to predict earnings ahead of time on the crowd-sourced earnings platform, Estimize. Using this model on over 1,000 quarterly earnings estimates, we've attained a very high analyst confidence score of 8.3/10. This is key as stocks that beat analyst estimates often see big jumps in price; thus it is crucial to have an idea of how earnings will come out ahead of time. DST's earnings estimate breakdown is shown below:
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With seven EPS beats in a row and nine beats in the last 10 quarters, DST has proven a consistent trend of beating earnings estimates. With last quarter's EPS surprising by 13.07%, and the quarter before by over 20%, it's likely that DST will beat the Wall Street consensus EPS of $1.29 by a very big (+7.5%) margin this time around. On a revenue basis DST has been slightly less consistent, but with five beats in a row and eight out of the last 10 beating estimates, there's evidence of a pretty strong trend. Due to the smaller size of DST's revenue beats (for example, 3.36% last quarter), we anticipate a small (0-2.5%) upcoming revenue beat for DST.
Qualitative and seasonal
Finally, we'll finish with a qualitative analysis of some of the potential growth catalysts for DST Systems while also considering the seasonal trend for Information Technology stocks during this time of the year.
With over 822 million data records compromised globally in 2013 at an average organizational cost of $3.5 million per event, the demand for top-tier data security will only continue to grow in the coming years. This, along with the trend of data analytics outsourcing, will position DST for growth in all of its clients' industries. The growth of ETFs and alternative asset classes (REITs and MLPs) is also a favorable trend for demand for DST's services amongst its asset manager clients. Finally, the aging population (with 10,000 baby boomers turning 65 every day for the next 19 years) is a boon for DST's services among its healthcare and insurance providers' clientele.
DST has reduced its total debt by over 60% in the last four years, from $1.38 billion in 2011 to $553 million in 2014. They also returned $447 million to shareholders in 2014, through the repurchasing of $400 million worth of shares and the issuance of $47.6 million in dividends. This shareholder return is over twice the $119 million returned in 2013. These are among the reasons why investors are so nervous to short the stock going forward. The chart below attempts to put DST's 0.06% short float into perspective with respect to its group (2.15%), sector (3.52%) and the market (3.20%) averages.
The final reason that we are bullish on DST is the historical performance of the IT sector vs. the S&P 500 during this time of the year. Since 1998, the S&P Information Technology (S5INFT) index has, on average, beaten the overall S&P 500 by 1.61% in March and 2.33% in April. Though it may not be the very best time of the year to buy IT stocks, it's still prudent to buy them now before April.
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To conclude, we're bullish on DST Systems for a number of reasons; its combination of value, momentum, growth, industry tailwinds, low short float, and good seasonal timing. We expect them to beat the consensus earnings estimates next month (April 23) and advise investors to consider taking a position before the impending gain.
