Thomson Reuters (NYSE:TRI) missed its second quarter earnings mainly due to lower revenue and weak margins in its Legal and Tax & Accounting division. The company reported revenue of $2.769b which is a 1% decline from the prior year and this missed the analyst estimate of $2.827b while EBITDA declined 2% from the prior year and came in at $757m. Earnings per share of $0.50 was a penny higher than the analyst estimate of $0.49. The company also reaffirmed its 2016 guidance and now expects single-digit revenue growth, EBITDA margin of 27.3% - 28.3% and free cash flow of $1.7b to $1.9b.
In my view, the weakness in Legal and Tax & Accounting was weaker than expected so this caused the sell off after earnings. For the week, Thomson Reuters' stock fell 4% compared with the S&P TSX that was flat so this was definitely not a good result. However, I think that the focus for this company will be on its softer organic revenue, especially in Financial and Risk division. Management highlighted that this division will continue to see positive sales growth and this is important because this division represents organic growth of the company. We could see gradual recovery in the second half as discount from prior platform migration will largely be factored in so this is not as bad as it seems.
When it comes to organic trends, overall growth was flat as the trends in Financial and Risk were offset by the trends in Legal, Tax & Accounting. Financial and Risk saw a slight decline due to a 17% drop in recovery revenue but the good news is that recurring revenue did not change and this once again supports my organic growth thesis. As long as recurring revenue remains intact, I think we could see better year-on-year comparisons going forward. However, a troubling sign is starting to emerge in the Peer Index Monitor for Legal activity in the US that interestingly showed a decline for the first time after 9 straight quarters. This could potentially be a concern in that the underlying growth of the industry may see a pull back. I am not ready to conclude this early because this is only one data point but this is definitely an area to be aware of.
Looking below the revenue, EBITDA margin declined by 20bps mainly due to Tax and Accounting but once again Financial and Risk margins held up really well. Tax & Accounting was impacted by the recent projects that the company undertook but since the project is largely done, I do not see this to be an issue going forward.
In conclusion, second quarter numbers were weak and there is no sugar-coat this but the strong guidance on organic growth in Financial and Risk in the second half was clearly a positive. I continue to see Thomson Reuters becoming a more focused company and I will hold this view for now. 2016 will progress slower than many people expected so we will have to wait until 2017 for more clarity on whether all the divisions will grow close to its full potential. Right now, Thomson Reuters is trading at 20.5x Price/Earnings ratio and 11.5x Price/Cash Flow ratio, which is at the high-end of its peer group so there is little room for disappointment. As we have observed this quarter, the stock underperformed the index by 4% after the earnings so if it underperforms again then we could see price/earnings ratio contract to 15x-17x, which is more in-line with its peers.
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