Accenture: A Recession-Resistant IT Stalwart
Accenture (ACN; recent price, 29) is the largest independent information-technology outsourcing and consulting company in the world, with operations in 52 countries and reported net revenues of $23.4 billion in fiscal year 2008 (ended August). It is organized into five major operating groups: Communications & High Tech, Financial Services, Products, Public Service, and Resources.
We view Accenture as a one-stop-shop IT services company. It is as adept, in our opinion, in providing infrastructure outsourcing or business process outsourcing as it is in management consulting for improving a client's customer-relationship management (CRM) processes or its overall business strategy. It also offers systems integration and technology consulting services.
Given Accenture's breadth of offerings and its broad geographic diversification, we think it is well-positioned to weather the current U.S. recession and global economic slowdown. We look for revenue growth of about 8% in fiscal 2009, although we expect the company to incur a headwind from the recent strengthening of the U.S. dollar. We think that management is doing a good job of maintaining margins in a difficult market, and we look for earnings per share of $2.87.
We also have a favorable view of the company's balance sheet and cash flows. At the end of August 2008, Accenture had over $3.6 billion in cash, with a debt-to-total capital ratio of under 0.5%. At the same time, it repurchased 60.8 million shares last fiscal year and paid a 50¢-a-share dividend in November. Cash flow in fiscal 2008 was nearly $2.5 billion. The company's solid balance sheet gives it the financial flexibility to continue to repurchase shares and potentially make acquisitions, despite the economic downturn, by our analysis.
We view the shares as compellingly valued, recently trading at around 10 times our calendar 2009 earnings per share estimate of $2.94, roughly in line with traditional IT outsourcing peers. We believe that a premium to peers is warranted, given our view of the solid revenue growth that the company has shown in its higher-margin consulting business, rising levels of bookings, and its solid balance sheet. We believe Accenture is one of the few IT services providers that has the expertise, size, and scope to compete head to head with industry heavyweight International Business Machines (IBM), while holding off challenges from lower-cost India-based providers.
The stock carries Standard & Poor's highest investment recommendation of 5 STARS, or "strong buy."
The company was established in 1989 and was initially known as Andersen Consulting. It began business focused on consulting and technology services, but it grew to offer a full range of consulting, outsourcing, and related technology services. On Jan. 1, 2001, the company severed ties between it and Andersen Worldwide Societe Cooperative and changed its name to Accenture.
Since its inception, Accenture operated as a collective of locally owned independent partnerships, but in July 2001, the company went public. At that time, partners and owners were given Accenture shares of various classes, which have become freely tradable over time, and more are eligible over the coming years. However, we expect the number of shares to hit the open market to be low.
The company's organizational structure is centered on five operating groups. Products was the largest in fiscal 2008 (25.9% of net revenues), which includes the automotive, consumer goods & services, health & life sciences, industrial equipment, retail, and transportation & travel service verticals. Next in size was Communications & High Tech (23.3%), which serves the communications, electronics & high tech, and media & entertainment industries.
Financial Services (21.4%), which saw growth of 14.9% in fiscal 2008 despite trouble in the industry, helps clients in the banking, capital markets, and insurance verticals. The Resources vertical (16.9%) comprises the chemical, energy, natural resources, and utilities sectors. Lastly, the Public Service group (12.3%), which works with all levels of government as well as some nongovernmental organizations (such as charities) was Accenture's slowest-growing vertical last fiscal year.
Tied to the operating groups are three "growth platforms," which include management consulting, systems integration and technology, and outsourcing. These groups provide services and solutions to the company's clients. Key service lines include customer relationship management, supply chain management, enterprise solutions and enterprise resource planning, service-oriented architecture, software as a service, application outsourcing, and business process outsourcing.
The company has done a good job holding the line on expenses in recent years, in our view. Part of that performance can be traced to Accenture's global delivery network. This allows the company to offer services from any of 50 delivery centers, depending on such factors as specialized skills, costs, foreign language abilities, and proximity to clients. At the end of fiscal 2008, the company had 186,000 employees, with 83,000 located overseas. Roughly half (41,000) of those workers based outside of the U.S. were located in India, with 15,500 in the Philippines.
We believe the revenue outlook for Accenture is positive, despite the difficult prevailing economic conditions. Bookings in the August quarter of fiscal 2008 were at a record high, reaching $7.67 billion. Bookings are a useful metric to determine the pace of new business signings, although the figures can vary from quarter to quarter, as the company tends to sign a small number of large contracts. Still, the latest figure was Accenture's seventh straight quarter of $3-plus billion in consulting bookings.
Within the bookings figure, we note that outsourcing bookings in the fourth quarter were at their highest level in the past two years. We believe that this may represent a shift by clients towards cost-saving initiatives. This shift gives us confidence that Accenture is able to offer its clients whatever services they may need, regardless of the economic environment. For example, within the utilities and natural resources area, consulting has seen greater demand, as the industry is experiencing an influx of new technologies on the one hand and is dealing with rapid changes in the price of commodities on the other. At the same time, Accenture is able to help troubled financial services companies by taking over noncore work, allowing its clients to deal with their more pressing issues, including bad loans and shaky consumer confidence.
We look for net revenue growth of about 8% in fiscal 2009, well below last year's 19% increase, which was aided by favorable foreign currency movements. Still, we think that the company is taking market share, as it is growing faster than the overall market. We look for continued strength in the Products and Resources verticals, but will be watching to see if the recently signed contracts in the Financial Services area translate into accelerating growth. We also have some concerns about the Public Service group, which has tended to be a laggard over the past few years. In fiscal 2010, we expect revenue growth of 7%.
We believe operating margins will continue to be a bright spot for Accenture. We look for operating margins of 13.5% in fiscal 2009, a slight increase over last year. The company's global delivery network has been partially responsible for its ability to deliver consistent value for its customers, as it is able to use exactly the right resource in the right place at the right price to service its clients. The platform has grown sharply over the last few years, and despite a net increase of 17,000 additional employees in fiscal 2008, Accenture has been able to keep utilization (84%) and turnover (16%) at reasonable levels relative to others in the industry.
Other factors positively affecting margins, by our analysis, include improving contract terms, cost-containment measures, and some price increases, in addition to what we view as solid execution by management. Still, we think the buildup of the global delivery platform and rising wages will offset some of those gains.
We look for earnings per share of $2.87 in fiscal 2009 and $3.13 in fiscal 2010, after operating EPS of $2.70 in fiscal 2008.
Accenture shares recently traded at 9.7 times our calendar 2009 earnings per share estimate of $2.94, which is roughly in line with its traditional IT outsourcing peers such as CSC (CSC) and Affiliated Computer Services (ACS), but a modest discount to its top-tier India-based competitors, such as Infosys (INFY), Cognizant (CTSH), and Wipro (WIT). We believe the shares should trade at a premium to its traditional peers and in line with the faster-growing India-based competitors, given our view of the wider margins afforded the company through its consulting business, its solid balance sheet, and its bookings growth over the past few quarters. The recent p-e is near historical lows, as the shares have ranged between 9.3 times and 25.8 times earnings over the past six years.
We base our 12-month target price of $35 on a p-e of 11.9 times our calendar 2009 earnings per share estimate. We also use a p-e-to-growth ratio of 0.74 times, assuming a three-year earnings growth rate of 16%.
We note the shares recently had an annual dividend yield of 1.7%.
We have a generally positive view of Accenture's corporate governance policies. A majority of the board is independent, there is no family or majority shareholder control, and we believe there is no poison pill or related party transactions. However, we note that the company's chairman and CEO positions are held by the same person. Additionally, there are multiple share classes as a result of the company's former ownership structure, which leads to a dilution overhang of over 30%.
Risks to our investment recommendation and target price include the possibility of increased competition, which we expect to become more intense as demand slows. Further, we believe that Hewlett-Packard (HPQ), which recently purchased Electronic Data Systems (EDS), will be a more formidable competitor in the future. As a result of this competition, it is possible that pricing pressures could arise, adversely affecting margins.
When dealing with clients, there is always the risk of contract cancellations, possibly at short notice. There is also the chance that a contract will become unprofitable and problematic, which happened in early 2007, when the company transferred the rights to an underperforming contract with the National Health Service in England to a competitor.
Other risks include the large diluted overhang of shares, which, if they came to market, would adversely affect the share price, and risks associated with foreign exchange, as the company collects revenue and incurs costs in many different currencies.
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