Should you buy, hold or sell IPH Limited shares?
In the previous financial year more than 42,000 patents and 69,000 trademarks were filed in Australia. Protecting intellectual property rights is an important element of business.
IPH Limited (ASX:IPH) is the leading IP services group in the Asia Pacific region. It is the leading patent group in Australia, New Zealand and Singapore and the top trademark group in Australia and New Zealand. It services eight IP jurisdictions across the region, in 25 countries and have more than 900 staff.
The company listed in 2014 and has grown through a series of acquisitions as well as organic growth. It now operates under six business units with distinct brands following some consolidation. It has made 11 acquisitions since listing, including taking over the listed Xenith Group in 2019 for US$109 million. In addition to the IP services, it has a software business that develops and markets a time-keeping tool to legal firms.
Whilst 75% of IPH's revenue is derived in Australia and New Zealand the remainder comes from the growing Asian operations. In addition to Singapore, it also has offices in China, Hong Kong, Indonesia, Malaysia and Thailand. The number of patent filings in key Asian markets have been showing double digit growth in recent years.
In Australia the total market for patent and trademark filings has been fairly steady although it did spike in the 2021 financial year but has since returned to more normal levels. In order to grow in this market it will need to increase its market share. To this end it has declined from 38% to 34% market share for patent filings citing a significant reduction in filings from its largest client as well as challenges with the integration of acquired businesses. On the other hand, it has managed to increase its share of the trademark business from 23% to 24%.
Another key driver of revenue growth is client referrals and the building of a network effect. As it now has a presence across Asia Pacific it is able to offer clients a comprehensive solution covering its needs to protect IP across multiple markets.
One aspect that can cause fluctuations in IPH's financial results is its sensitivity to currency movements. 60% of its expenses are incurred in Australian dollars whereas only 21% of revenue is received in AUD. 54% of revenue is booked in US dollars but none of the expenses are incurred in USD. This mismatch can cause volatility in earnings as exchange rates fluctuate. As the $A falls the value of $US revenues increases and vice versa. In the last year the $A has fallen but in the previous year it rose. Rather than incur the cost of trying to manage this exposure through hedging, management simply accept it as a variable in the business and provide the market with transparency around the currency exposures.
Over the past five years revenue has grown at 18%, however profits have only grown at 7% and earnings per share (EPS) at 2.6%. Net profit margins have declined from 27% to 16%. In other words, as revenue grew the level of profitability has been declining. This warrants keeping a close eye on. Some of it may be due to the currency issue, but it would also appear that there have been challenges integrating the acquired businesses and that the investments have not always yielded the expected synergies.
Return on equity has also declined from 19% to 12%.
Despite these declines, market analysts are expecting a significant 50% jump in EPS in financial year 2022. This comes on the back of a solid half year result. This is due to a combination of increasing revenue and declining expenses.
Cash flow has been consistently strong, enabling debt to be paid down. The debt to equity ratio is only 10%. It is worth noting that intangible assets exceed the value of total equity. This reflects the multiple acquisitions over prior years.
IPH is a solid business with a strong position in Asia Pacific in its niche focus area. If it shifts the emphasis from acquisitions to more organic growth it has the operating leverage to increase profitability. But it will not be simple. It is a competitive space and a potential pull back in economic activity could also have a dampening effect on the number of filings.
Based on forecasts, the stock is currently trading on a PE ratio of 19 and a dividend yield of 4.2%. Given the prospects, this represents fair value but could not be described as a bargain. However with the current volatility on the share market a bargain opportunity may present itself soon.
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