The Class Ltd (ASX: CL1) share price has been on a rollercoaster over the last year, but is it a great buy?
Class is a cloud accounting software provider for self-managed superannuation fund (SMSF) administrators with a market capitalisation of $358 million.
I think Class is a great business for the following reasons:
Revolutionising an industry
The key difference that Class offers compared to its competitors is that it offers a much higher level of automation through the cloud. This generates large efficiency gains for accountants, therefore making jobs a lot more profitable for them.
The cloud aspect also offers administrators a lot more flexibility so that they can access work wherever and whenever they want to.
Accountants love the Class setup. In fact they love it so much that Class has been achieving a retention rate of over 99% for the last few years. It would take a much cheaper or superior product for clients to move to a competitor.
High profit margins
The nature of software means that once it has been developed there aren't many costs to increase the distribution of the service. This results in a high earnings before interest, tax, depreciation and amortisation (EBITDA) margin, which in Class' case was 45.3% in its results to 31 December 2016.
High profit margins mean that as the business gets bigger, more and more of the extra revenue will fall to the bottom line, making Class very profitable.
Growing market share
Class started off with a very small market share of the SMSF market. However, every quarter it adds thousands of new SMSFs to its client base and had 127,806 at the end of 31 March 2017 which is a 21.7% market share.
The more Class grows the more it cements itself as the number one provider, which should mean it maintains its high retention rate and keeps adding new SMSF portfolios at a fast rate.
Risks
A near-term risk is that AMP Limited (ASX: AMP) plans to take its SMSFs off Class and move them in-house. Class revealed that this represents 7.2% of annual committed revenue and AMP plan to move them off by the end of this year.
The longer-term risk is that a competitor, such as BGL, creates a product of similar quality and price which would stop Class winning so much new business. This would make the current price/earnings ratio seem too high.
Foolish takeaway
Class is trading at 59x FY16's underlying earnings per share, which is high and has a lot of future growth baked into the share price.
The grossed-up dividend yield of 1.87% is decent but investors hoping for income will have to be patient as the business grows its profit and dividend.
I think Class is a great business to own but the current price of $3.05 could be a bit high in the short term, especially as AMP will take its SMSFs in-house. Over the next few months I'd be looking to buy at a price at least under $2.80.
