Expanding Into Insurance Consulting Will Improve Efficiency, But Competitive Challenges And Margin Pressures Will Persist

Key Takeaways

• Implementing the Aurora platform is expected to boost operational efficiency and EBITDA margins by replacing costlier third-party providers.
  
• Increasing regulatory requirements may drive demand for advisory services, potentially growing revenue as clients navigate new pension regulations.
  
• Market competition, declining defined benefit schemes, and execution risk in diversification pose challenges to XPS, while relying on M&A for growth increases financial risk.

Catalysts

Provides employee benefit consultancy and related business services in the United Kingdom.

• The company is expecting significant growth in the actuarial and administration divisions, especially with the implementation of the Aurora platform by 2027, which is anticipated to improve operational efficiency and margins further. This platform will replace third-party providers, thereby reducing costs and improving EBITDA margins.
  
• The regulatory landscape is changing with new pension regulations that require clients to seek more advisory services, which could increase demand for XPS’s services and thus potentially grow revenue as they guide clients through these new regulatory requirements.
  
• As part of an investment strategy, focus on expanding into adjacent markets such as insurance consulting could open new revenue streams, particularly tapping into the £1 billion market related to insurance companies’ external consultancy needs.
  
• The positive cash flow allows for progressive dividend policy and reinvestment in technology and AI to enhance internal efficiencies and service offerings. This strong cash generation and low leverage could lead to improving net margins and shareholder returns.
  
• The ongoing consolidation in the pensions and insurance market could present opportunities for strategic M&A, potentially boosting earnings through acquiring complementary businesses that enhance service offerings and market share.

XPS Pensions Group Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming XPS Pensions Group's revenue will grow by 6.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 28.3% today to 11.5% in 3 years time.
• Analysts expect earnings to reach £30.7 million (and earnings per share of £0.17) by about January 2028, down from £61.7 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 29.5x on those 2028 earnings, up from 11.5x today. This future PE is greater than the current PE for the GB Capital Markets industry at 11.6x.
• Analysts expect the number of shares outstanding to decline by 4.16% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.24%, as per the Simply Wall St company report.

XPS Pensions Group Future Earnings Per Share Growth

Risks

• XPS Pensions Group operates in a highly competitive market with major players like Mercer and Willis Towers Watson. This could impact their ability to capture market share and affect future revenue growth.
  
• The company faces the long-term risk of a declining number of defined benefit pension schemes, which are a core part of their business. This could potentially decrease their revenue base over time.
  
• With high dependency on regulatory changes and market volatility to drive demand, any stabilization in these areas could lead to reduced client demand and impact revenue.
  
• While XPS Pensions Group plans to broaden into insurance and other financial services markets, there is execution risk in these expansions. If not managed well, it could lead to increased costs without commensurate revenue growth.
  
• Despite currently low debt levels, significant reliance on continuous M&A for growth could lead to increased financial risk and affect net margins if synergies are not realized as planned.

Valuation

• The analysts have a consensus price target of £4.04 for XPS Pensions Group based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be £266.6 million, earnings will come to £30.7 million, and it would be trading on a PE ratio of 29.5x, assuming you use a discount rate of 7.2%.
• Given the current share price of £3.43, the analyst's price target of £4.04 is 15.0% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.