As the credit crunch unfolds, I have adopted a couple of key principles for stock-picking. Firstly, with deleveraging cutting off liquidity, I prefer companies with strong market positions and plenty of cash. Secondly, I like sectors that offer resilience during the harsher times ahead – for example, those which save customers’ money or have good recurring revenues. One such opportunity is Amdocs, the world’s top provider of invoicing and customer service software for telecommunication operators such as AT&T, Bell Canada, O2 and Vodafone.
Amdocs (NYSE: DOX), rated a BUY by Merrill Lynch
For the year ended September 2008, turnover and underlying earnings per share (EPS) were $3.16bn (up 11.5%) and $2.29 (up 7.0%) respectively. More than 1.3 billion people are supported by its applications globally. The firm’s closing order book (which includes committed revenue from managed services contracts, letters of intent, maintenance and estimated ongoing support activities) was a healthy $2.4bn, around 75% of this year’s sales target.
So why has the share price dropped by around 48% since January? Oddly, one issue has been its success in winning new contracts, which have temporarily trimmed margins. For example, it recently finished a huge project for Sprint/Nextel (requiring up-front investment), to switch all of the 53 million subscribers from a rival system (provided by Convergys) on to a new single, unified platform. But this migration, alongside new consulting and service contracts with AT&T, should keep profits ticking along in 2009.
Another problem has been the dollar’s recent strength, which shrunk EPS by eight cents in the fourth quarter of 2008 and will also be a headwind going forward. What’s more, the lower interest earned on its $740m cash pile (from lower rates), along with uncertainty over future customer spending, led to 2009 top-line forecasts being cut to “flat-to-low single-digit percentage growth”. Even so, CEO Dov Baharav did state that “we are not seeing order cancellations, and have continued to sign new deals”. Other fears include geopolitical troubles, as many of Amdocs’ staff work in Israel. The firm’s high dependency on a few large clients is also a worry and could put pressure on pricing as the sector consolidates.
That said, many telco operators are quasi-utilities with predictable revenues, while Amdocs has good earnings visibility and a rock-solid balance sheet. One could argue that if there is an economic slump, its robust financial position will enable it to improve its hit-rate on new bids, as customers worry that weaker suppliers of these vital systems could go to the wall.
The stock is now trading at near five-year lows, and on multiples of less than nine-times earnings, which looks appetising to me. In fact, at these levels Amdocs could be vulnerable to a predatory takeover from the likes of IBM, SAP, or even Oracle. Should a deal happen, it could easily be for more than $40 per share. Merrill Lynch has a $30 target price on the stock.
Recommendation: long-term BUY at $18.00 (market cap $3.7bn)
Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.