Via SeekingAlpha.com

Investment Thesis

We recommend a BUY rating for Accenture plc (NYSE: ACN). The stock represents good value with an estimated upside of 17%, trading at an EBITDA multiple of 13.15x.

The upside potential is driven by 1) high industry growth fueled by cloud, security, Internet of Things (IoT) and blockchain, which account for about 65% of the company’s sales 2) a leading presence and competitive edge with customer relationships and a diversified business mix 3) strong free cash flow with no net debt, which provides great optionality to build (or buy) digital capabilities to drive future organic growth. The company also has a solid tenure management team with a strong track record in reinventing and investing aggressively in emerging technologies and have outpaced its competitors. Downside risks are lower IT-services spending environment, lack of strategic M&A and the ability to attract and retain talent. Overall, Accenture has showcased consistent top-line and bottom-line growth, outperforming its peers in growth and industry presence

Q2 2020 Earnings Call and COVID-19 Impact

  • On March 19, 2020 Accenture plc (ACN) surpassed the consensus estimate for earnings and revenues. Earnings of $1.91 has increased YoY by 10.4% as well as bottom line benefiting from higher revenues, operating results and non-operating income.
  • ACN forecasts lower-than-expected quarterly revenue on coronavirus fears with potential project delays and slowing consumer spending.
  • The company expects 2020 revenue growth between 3% to 6% from prior forecast of 6-8%.
  • CEO Julie Sweet believes Accenture is positioned well due to a virtual team structure, a standing crisis management committee, virtual working expertise, staff retention and services relevance.
  • Service relevance: 60% of the business revolves around deep client relationships with the world’s leading companies. ACN’s business model enables the company to help clients succeed in uncertain periods and position for the long-term.

Industry Drivers: Cloud, Cybersecurity and Analytics

The explosive growth for cloud-based applications have created a growth space for the IT-services industry. With salesforce.com (CRM) leading the implementations, the industry is experiencing a greater need to deploy other Software-as-a-Service (SAAS) products (ie. Workday and ServiceNow). And as part of the process, system integrators such as Accenture helps in shifting data from legacy applications to newer products.

Customers upgrading their older systems to the modernized IT-infrastructure have also created a greater demand for hybrid-cloud services, offered by IBM, Accenture, Tata Consultancy Services, Infosys, Cognizant and Capgemini. In addition, managed-cloud services have also been experiencing a larger demand as the IT-services companies help customers host their infrastructure on the public cloud, usually offered by Amazon.com, Microsoft and Google.

Source: Image created by author with data from Bloomberg Intelligence, IDC

Catalyst: Emerging Technologies

Cybersecurity

An increased growth in cybersecurity has been fueling strong revenues for the IT-services industry. A rise in global cyberattacks and changes in regulations are forcing companies to increase security spending. More dollar flows have been associated with advanced security utilizing analytics and IoT security (Source: Bloomberg Intelligence). Per Accenture’s business, cybersecurity within Accenture Consulting is now a $2 billion business

Internet of Things (IoT) and Blockchain

Although Internet of Things (IoT), blockchain, AI and the integration of all three are still in the beginning stages, the blockchain platform with IoT will become the next big growth driver in the industry, along with cloud and security. IT service enterprises have been rapidly accelerating the investments related to IoT and blockchain, which has a potential economic impact of $3.9 trillion to $11.1 trillion by 2025 (Source: McKinsey & Company). According to Gartner, a global research and advisory firm for IT service leaders, 75% of organizations have integrated IoT with blockchain in 2017. Two years later, the number rose to 89%, which signals a continuous growth for a digital transformation and innovation.

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Catalyst: Leading Presence

Customer Relationships

Accenture possesses the most diversified business in the IT services industry. The firm also maintains around 70% of its head count in low-cost locations, which is the highest amongst the legacy IT services firms. In addition, Accenture’s customer relationships and industry expertise sets the company apart from its peers. The company’s strength in its “C-Suite relationships” is indicated through winning business on a sole-source basis. Current client list include 94 of the Fortune 100 companies and more than 80% of Fortune 500 companies. More than 200 “diamond” customers contribute about $100MM in annual revenue.

Strong Pipeline for Bookings Growth

Bookings strength has been driven by the demand for digital, cloud and security related services, which represents ~65% of the total. Bookings tend to start lower in the beginning of the year and build throughout the year. Nasdaq is expecting Accenture’s total bookings to grow at a CAGR of 4.7% (Consulting: 5%; Outsourcing: 4.4%) , surpassing $50 billion by 2022 and reaching $53.8 billion in 2023. Although Accenture competes against big names like IBM, McKinsey and Infosys, the company’s push into the “New” (digital, cloud, security) will be a growth advantage over companies tied to legacy IT outsourcing.

Source: Image created by author with data from ACN 10k, NASDAQ, Treifs

Business Model for Competitive Edge

Accenture’s culture is deeply embedded with reinventing and investing aggressively in emerging technologies to grow faster than its peers and the overall industry. The company will be investing about $2 billion in fiscal 2020, outpacing its competitors. This will also result in sustaining above-industry sales growth for the foreseeable future. For example, the entrepreneurial culture in expanding into low-cost regions in the early 2000s and transitioning early into cloud-related practices allowed the company to outpace its direct competitors. In addition, Accenture’s large operational network is another competitive advantage and allows the company to scale new practices. The company also spends about $700 million to train about 500,000 employees for high-value IT work –which is more than its peers. It is highly critical to maintain top skilled labor –especially in security, cloud and AI –so maintaining a large pool of trained employees will offer a competitive edge as well.

Market Share Gain

India ties with China as second most disruptive tech market and is one of the largest IT services and outsourcing hubs in the world, as the country provides a breeding ground for IT consultancies. Several players have struggled to outperform Indian IT services firms since 1989. Indian Tier -1 giants include Infosys, Cognizant, Wipro and Tata Consultancy Services. However, Accenture has been expanding its market share within the industry (Source: Normura Financial Advisory & Securities). The market share of Tier-1 companies saw 0% growth while Accenture grew its market share by 0.6%. In addition, Accenture’s revenues experienced a growth rate of 13.5% throughout 2018 while other IT firms grew at a rate of about 8.5%. Analysts are attributing Tier-1’s slowing of growth to a lower digital exposure. Accenture has been active in developing its digital capabilities globally with about 65% of its sales generated from emerging technologies versus 30% of sales for other Tier-1 IT companies.

Catalyst: Free Cash Flow – Best in Class

Accenture’s attractive free cash flow profile offers a possible defensive opportunity. The company has a high-cash generating business model where it trades (FCF yield) at ~6% vs peers ~4% (Source: JP Morgan). ACN reported $1.9BN in FCF for 4Q19 and $6Bn in FCF for FY 19, and returned $4.6BN of cash to shareholders through share repurchases and dividends, with about $1.9BN invested in 33 acquisitions. Accenture’s cash ability to invest will allow the company to focus on its acquisition strategy of using inorganic growth as an engine for organic growth. The company’s financial flexibility of no net debt, combined with buybacks and dividends, makes Accenture defensive in a deteriorating macro environment. In three of the past four major downturns IT spending in the United States fell twice as much as the GDP did and dipped increasingly in the fourth. However, other Info Tech subsectors such as hardware and semiconductor have been hit much harder than security software services (Source: McKinsey). In 2008, IT spending was projected to be -0.9%, a substantial decrease from pre-crisis forecast of 4.2% growth (Source: Forrester, Gartner, IDC).

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Source: Image created by author with data from Bureau of Economic Analysis, The Economist, IDC, McKinsey Analysis

However, the economic recession has left room for IT spending priorities in software storage, business intelligence (analytics), virtualization, security and cloud computing. As it is uncertain when the next economic downturn will be, Accenture’s business model, again, in evolving along with the emerging technologies will be able to capture the continuing need and growth in the industry. In addition, despite the uncertainties in 2018 and 2019, IT budget increased significantly from 46% in 2017 to 55% in 2019 (Source: KPMG).

Acquisitions

Given the strong balance sheet, Accenture has great optionality to build and/or buy digital capabilities to drive future organic growth. The company typically allocates about 25% of its operating cash flow in acquiring smaller businesses to gain about 2-3% of inorganic annual revenue growth. In FY19, Accenture invested about $1.9BN in 33 acquisitions targeting high-growth segments. According to Accenture, the company analyzes three main areas for deals: where they need to scale, add new capabilities and/or add industry expertise. 20 out of the 33 were invested in new capabilities in digital and security; 4 out of the 33 consisted of deepening the expertise in the financial services industry. The company has already invested in at least 7 acquisitions in fiscal year 2020 and will continue to invest for future growth. With a strategic acquisition focus on the “New” (digital, cloud and security services), the inorganic growth will be a fuel for future organic growth and the excess capital will be provided as a return to the shareholders through dividends and repurchases.

Source: FactSet

Financial Health

Source: Image created by author with data from FactSet, Finviz

Accenture plc’s debt is well covered by operating cash flow by 32,984.6%. The company’s debt is covered by short term assets, in which the assets are 774.9x debt. The company’s ROE of 34.30% is considered very high compared to the IT industry’s ROE of 16.9%.

Relative Valuation

Source: Image created by author with data from FactSet

Accenture is trading at a higher multiple against its peers and the IT services industry. We observed that relative valuation does not account for the fact that there was a plummet in price due to the COVID-19 fears despite the company beating estimates for 2Q earnings. As ACN has experienced a higher EPS growth YoY compared to its peers, we conclude that there are potential upsides to the stock price amid the market volatility.

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Risks

A Deteriorating IT Spending Environment

Although the drivers for the IT services industry will continue to be a catalyst, global macroeconomic and geopolitical conditions may affect the customers’ businesses and the levels of business activity. A deteriorating IT spending environment may reduce the demand for Accenture’s services and solutions.

Lack of Strategic M&A

Accenture plc typically acquires small companies to scale-up emerging technologies to boost its portfolio. If the company fails to invest in acquisitions, it may start losing its competitive advantage and lose out on growth opportunities. For instance, acquisitions in fiscal 2019 contributed approximately 2% to top-line gains, and 2.5% in 2018. Accenture’s strategy of acquiring next-generation enterprises and then scaling up (easier to complement with existing business offerings), has been a substantial driver of Accenture’s above-industry sales-growth rate (Source: Bloomberg Intelligence).

Source: Image created by author with data from ACN 10k, Bloomberg Intelligence

The Ability to Attract & Retain Talent

Accenture’s business is largely dependent on the ability to supply market-leading skills with client demand and the ability to attract, retain and motivate talent. Failure to acquire and retrain hires to innovate and deliver new solutions in a rapid environment will adversely impact client demand. There is an intense competition for scarce talent who possess the knowledge and skills for emerging technologies, and Accenture’s competitors have directly targeted ACN’s employees with highly sought-after skills.

Conclusion

In conclusion, I recommend a buy for Accenture plc. The shares are slightly undervalued due to the dip in the market with significant upside driver potential. The company’s aggressive investments into emerging technology have resulted in market share gain, as the implementation of IoT, AI, blockchain and cloud have allowed ACN to capture opportunities. With today’s uncertainty, Accenture is a good company because of its strong balance sheet (negative net debt) with massive cash flow that provides cushioning during economic downturns. During the Q2 2020 earnings, management stated that the firm still has about $500mm reserved specifically for potential acquisitions. Stats below show Accenture’s strong position with its customers.

TMT-

  • Communications: 95% of the world’s 20 largest communications companies
  • Tech: 80% of the Fortune 500’s electronics and high-tech companies
  • Media: 67% of the world’s 50 largest media companies and all the major Hollywood studios

Finance-

  • Banking: 80% of the top 50 banks on the Fortune Global 500
  • Capital Markets: 19 of the top 20 investment banks world-wide
  • Insurance: 35 of the world’s top 40 insurance companies

Auto, Industrial, Infrastructure & Travel (AIIT)- in Europe: help make more than 2bn trips each year faster and easier, process 300 million airline ticket reservations

Consumer Goods & Services- help support or process 50% of beer sold on the planet.(18.5Tn pints of beer per year)

Life Sciences- Helped one of the world’s top pharmaceutical companies reduce time-to-market by one third, bringing life-enhancing drugs to patients faster

Retail- Accenture processes $1tn in purchases each year around the world; helped 1 million Americans complete 30% of Black Friday’s total online sales.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.