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October, 201410:34 AM

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IT stock on buy list

IT stock on buy list

From February/March lows some incredible rallies have been witnessed in the IT sector and one company in particular is benefiting from the strong sector re-rating.

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By Expert Panel 14.09.2009

Company: SMS Management & Technology Limited  

ASX Code: SMX

Share Price: $4.85

Market cap: $320m

Recommendation: Long-term ‘Buy’

At the epicentre of the tech bubble was the NASDAQ market. It is the largest exchange in the US with around half of its member companies sitting under the technology category. Accordingly, the NASDAQ lost almost 80% in value when the tech bubble popped in 2001/2002. Half of the ground was recovered in the next 6 years, only to have the “global financial crisis” unwind all the hard work.

Despite the heartache caused by the GFC, key levels have not been breached and a very strong rally in the order of 50% has occurred. Being one of the few market indices to post a fresh ‘recovery high’, it appears technology may be leading the way out of the world’s economic contraction… And here’s a potential way to capitalise.

Although Australia may be light-on when it comes to global IT powerhouses such as IBM, Microsoft, Apple, Google and Intel (just to name a few), leading local IT specialists have confidently weathered the storm and are emerging from the GFC ‘ready to roll’.

From February/March lows some incredible rallies have been witnessed in the IT sector and further long-term capital growth is likely as the market factors in a resilience of demand for mainstream IT services. A company benefiting strongly from the sector re-rating is SMS Management and Technology Limited (SMX), a pioneering contractor with a hand in all pieces of the IT services pie.

Established in 1985, SMX is one of Australia’s leading management services company. The company employs around 1,200 permanent and contract staff throughout Australia and specialises in improving operational performance and IT delivery. SMX does this by focusing on the way people, processes and technology are used by businesses.

The company addresses everything from business integration to compliance, process improvement to change management, and technology strategy to systems integration and application development.

In terms of scale, SMX is a 2nd tier IT services company (similar to Oakton (OKN)) with the likes of IBM and Accenture occupying the larger contract space. SMX has carved a niche in its corner of the market and is a clear industry leader.

Cyclical in their treatment by investors, Australian IT companies were priced for virtual oblivion during the unfolding of the GFC. From a high of $8.22 in Dec 2007, SMX’s share price fell 80.3% to a Feb 2009 low of $1.62! This sort of collapse suggested investors thought demand for contracting would come to a complete halt and SMX even struggle to survive… The company was a clear cut example of the old adage, “shares go up the stairs, but down the elevator”, and the majority of its peers did not escape a similar lashing.

In vast contrast to the fears at the time, although SMX has not risen from the downturn totally unscathed, its outstanding track record of EBITDA growth has been kept largely intact and only a decline of 5.4% occurred during FY09 - a considerable achievement in the face of the worst trading conditions since the turn of the century. Based on management’s track record and with the worst of the downturn behind them, we expect EBITDA growth rates to gradually return to prior levels of +20% p.a. Even taking into account the past year’s performance, SMX averages an annual growth rate to EBITDA of 40.1% (over the last 5 years).

While we don’t expect these sort of astronomical figures to be maintained forever, a +20% growth rate p.a. is quite easily reachable leading into FY10.

Possibly the best indicator for SMX’s outlook has been a stabilisation in the number of billable staff. The demand for IT contracting has a strong correlation with staff numbers and having cut 14% of billable employees in FY09, management have indicated no further reductions are required, and hiring is actually recommencing. Furthermore, with a majority of revenues stemming from government and big corporate contracts, cashflows from earnings are resilient. Management continues to win additional service contracts and the opportunities pipeline is never empty.

Highlighting SMX’s operating strength - particularly during the downturn - has been the ability to remain debt free and hold a cash balance of $26.5m. Trading on an undemanding forward PE of 13 (for a premium business) and offering a healthy 5.5% dividend yield out of cashflow, we expect that management will capitalise on improving trading conditions and business confidence.

A 'bottoming out' of the cycle for IT companies is being witnessed across the board, evidenced by a distinct bullish channel in SMX. The company needs only to maintain its current rate of growth (which is historically low) for our estimates to be reached. ‘Long-term buy’.

Joshua Terlich is an analyst at wise-owl.com. All views in this article are those of wise-owl.com, not of TheBull.com.au and do not constitute advice.  

 

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