Last week Hewlett-Packard announced an audacious $13.9bn acquisition of EDS, catapulting the enlarged group into second spot, behind IBM, inthe global IT pecking order. This type of deal shows that those “in the know” recognise the sector’s hidden value and its increasing resilience to economic woes.
I don’t, for example, think future IT profits will drop off a cliff as they did after the dotcom bubble. Indeed, growth in corporate IT budgets has been comparatively modest over the past five years, so there’s not much excess IT fat for businesses to trim. Plus the City has failed fully to grasp that in many cases IT is now a “must-have”.
Tip of the week: Logica (LOG), rated as ADD by Evolution Securities
Enter Logica, Europe’s seventh-largest IT provider with turnover of £3.1bn. The firm offers IT consulting, systems integration and business process outsourcing to sectors ranging from industry and transport (30% of revenues), Government (28%), banking (18%), energy (16%) and telecoms (8%). It also enjoys a wide customer base, predominantly in Europe.
Yet Logica’s shares have performed abysmally in the past year after suffering from a profit warning and the loss of some directors last May. The resulting sell-off looks overdone.
The main reason I say this is because of the appointment in January of a new CEO, Andy Green, who cut his teeth building BT’s successful IT services arm. Green hasn’t wasted any time at Logica – in April he announced a £110m restructuring plan, involving 1,300 job losses, which should save £80m annually and nudge operating profit margins up from 7.6% to 8.6% by 2010. The medium-term aim is to deliver margins of 10% plus, comparable with many of its European peers.
The early signs are positive, with last week’s reported like-for-like first quarter revenues up 3.6% – yet the stock trades on undemanding p/e ratios of 11.2 for 2008 and 10.4 for 2009, and also offers a chunky 4.6% dividend yield. I put Logica on a forward enterprise value to operating profit (EBIT) multiple of 11, which after deducting net debt of £557m and a pension deficit of £37m, generates a fair value of about 150p per share. The stock therefore appears well underpinned, with further potential upside from takeover interest.
Risks currently include rather high debt levels (albeit interest payments are over seven times covered) and the generic risks that come with managing large outsourcing contracts. Nonetheless, with an attractive valuation and small market cap, Logica looks to be good value.
Recommendation: BUY ON THE DIPS (market capitalisation £1.8bn)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments