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Are Class Ltd (ASX:CL1) shares cheap?

The share price of financial software services provider Class Ltd (ASX: CL1) has fallen 19% in FY19 because of a slowdown in new account wins in the SMSF software market. The company’s performance over the last 12 months has also lagged other fintech growth stocks such as Praemium Ltd (ASX: PPS) and Hub24 Ltd (ASX: HUB).

In FY18, Class saw operating revenue grow by 18% to $34.0 million with diluted earnings per share up 9% to 7.3 cents. The increase in revenue was not matched in the bottom line due to a fall in profit margins. The jump in revenue was fueled by the 25,469 new accounts Class won in SMSF and Portfolio in FY18, with the company’s market share in the SMSF software market climbing from 24% to 27%.

After a brief rally following the release of its full-year earnings, Class’ share price has resumed its fall. Currently trading for $1.95 the stock trades at levels not seen since March 2016. Consensus estimates for FY19 earnings are currently 7.70 cents per share, which prices Class on a forward valuation multiple of 25.

A flat second half

Despite record account growth in the December and March quarters, the June quarter was weak as competition in the market intensified. Revenue was flat in the second half when compared to the first half.

Of particular note was the decline in average revenue per user (ARPU) from $216 to $215 in Class Super and from $147 to $139 in the smaller Class Portfolio. Customer acquisition costs (CAC), which measure sales, marketing and implementation expenditure divided by gross new accounts won over a rolling 12 month basis also rose from $114 to $144.

Foolish takeaway

Class is a high quality business operating in a niche market. I think there is a reasonably good chance that the company can become the market leader in the SMSF software space and surpass the incumbent BGL.

The company’s recurring revenues are sticky with a customer retention rate of 99.5% in FY18, although this excludes the ~2,700 accounts AMP Limited (ASX:AMP) moved off the platform during the year.

At 25 times forward earnings, shares of Class are cheaper than they have traded for in recent times. However, the reduction of its premium valuation multiple is justified by the slowing growth rate of new accounts added and a flat second half as the market adjusts its expectations moving forward.

Furthermore, possible legislative changes regarding the refunding of imputation credits and its ramifications on the SMSF industry is another issue for investors to keep in mind.

With all that in mind, I’m on the sidelines for now and will wait for the September quarter update before reevaluating the company.

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Motley Fool contributor Tim Katavic has no financial interest in any company mentioned. The Motley Fool Australia owns shares of Class Limited. 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 Scott Phillips.

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