Narrow moat-rated Link Administration remains significantly undervalued says Morningstar equity analyst Gareth James, despite reporting a 12 per cent drop in revenue and an after-tax loss of $114 million.

Investors headed for the exits on the news and the share price of the financial services admin provider fell by over 9 per cent.

Despite the negative headlines, James has maintained his fair value estimate for Link (ASX: LNK) at $7.70, saying the results “do not represent the underlying financial performance of the company.

The shares are currently trading at close to a 48 per cent discount. 

“Comparison of fiscal 2020 financial statement metrics with the prior year is distorted by the sale of CPCS (Corporate and Private Clients) business and the adoption of the AASB 16 lease accounting standard,” James said.

Australian Accounting Standards Board 16 introduces a single lessee accounting model and requires a lessee to recognise assets and liabilities for allleases with a term of more than 12 months, unless the underlying asset is of low value.

The overall 12 per cent fall in revenue was heavily impacted by the sale of the UK Corporate and Private clients business in 2019.

Excluding the transaction, revenue only fell 3 per cent. James characterised this as a relatively stable performance in light of the covid-19 pandemic and “reflective of the relatively defensive and recurring nature of Link’s revenue.”

Link Adminstration (LNK) - 1YR

Link Administration (LNK) - 1YR

Source: Morningstar Premium

Link Administration is the largest provider of superannuation administration services and the second-largest provider of share registry services in Australia.

It has created a narrow economic moat – which implies a ten-year competitive advantage – in the Australian and UK financial services administration sectors via its leading positions in fund administration and share registry services.

Client retention rates exceed 90 per cent in both markets, underpinned by inflation linked contracts of between two and five years.

James expects Link to benefit from continued outsourcing of fund administration functions, which are expected to accelerate as the industry consolidates.

Outgoing Link managing director John McMurtrie suggested that industry consolidation had been put on hold due to the covid crisis, but talks had resumed.

"The big game at the moment is further administration inflows and the potential for fund mergers,” McMurtrie said.

“We believe our client base will be in the ascendant in those conversations." 

Another source of growth for Link is the real estate transaction platform PEXA. Link has a 44.2 per cent stake in the company, which saw transaction volume grow by 37 per cent in fiscal 2020.

In addition to continued revenue growth, James also expects cost-cutting to further boost Link’s profitability. He lauds the capital-light business for its cash conversion capabilities and forecasts steady dividends.

Link announced a final dividend of 3.5 cents per share, 50 per cent franked.

Visit Morningstar's Reporting Season 2020 coverage. The calendar will be updated daily to connect you with our equity analysts' take on the financial results.