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Why I think OFX Group Ltd shares are a buy

Credit: 401(K) 2012

OFX Group Ltd (ASX: OFX) owns and operates namesake forex trading platform, OFX (formerly known as OzForex). The company listed on the ASX in October 2013 at $2 per share, surging over 28% on the opening day to close at $2.59. The stock went on to reach an all-time high of $3.55 in November last year, representing a massive 177% return for initial investors.

However, 2016 has been a year to forget for shareholders with the stock down over 42% this year after the unsuccessful takeover offer from Western Union. With the stock once again trading near all-time lows, after breaching its $2 issue price for the first time since listing in February, I believe OFX could provide a compelling opportunity for long-term investors.

About OFX

OFX was founded in 1998 and has fast become one of Australia’s largest foreign exchange and specialist international payments services providers. The company has significant operations in Australia, Canada, Europe, the Asia Pacific, the United Kingdom and the United States, enabling it to provide payment solutions to customers worldwide.

OFX leverages this worldwide network well, generating over half of its 2016 revenue from outside Australia and New Zealand in a sign that its business is transforming into a truly global player.

Financials

In 2016, the group reported global turnover of $19.6 billion across some 784,200 transactions. Operating income came in at $104 million for the full-year, translating to underlying net profit of $23.9 million (which was down marginally on the prior year).

Importantly, both average transaction volumes and active clients increased 5% and 6% respectively, auguring well for client quality and future profitability given the scalability of its business. This allowed management to provide a forecast of 2017 full-year earnings (EBITDA) to be higher than the full-year 2016 numbers.

Industry headwinds

Ordinarily, a rosy outlook on earnings should see shares surge given the prospect of higher profits. OFX shares, however, have gone the other way, slumping over 17% since reporting full-year results in May.

I believe the cause for OFX’s slump in share price is that it operates in a sector where competition is increasing and this is resulting in diminishing returns.

Although management expects overall earnings to increase, margins are expected to take a hit as low barriers to entry mean the likes of Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) can flex their muscle to take a slice of OFX’s market share in the foreign exchange and international payments market.

This suggests the industry could become crowded over the coming years, leading to industry consolidation if earnings attrition persists.

Foolish takeaway

OFX shares currently trade on trailing price-earnings of just over 20.5x. With management indicating growth in earnings in 2017, I calculate the stock trades on a forward price-earnings of about 19.5x at current prices (based on consensus EPS growth of 5%).

Whilst this still remains relatively expensive for a financial stock, industry consolidation could soon be on the cards for the sector. As such, I perceive any downside risk in OFX’s shares to be mitigated by the potential for a takeover offer if prices continue to decline.

Accordingly, I rate OFX as a buy at current prices.

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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