Accenture On A Roll (ACN)

By Hans Wagner | May 01, 2007 AAA

Accenture (NYSE: ACN) is achieving respectable success in both of its business segments, consulting and outsourcing. The business has a natural flow, as consulting often provides the lead-in to outsourcing opportunities.

And when this flow is working well, it generates the kind of results the firm is now experiencing. Accenture is also benefiting from its significant IT development capability in the Philippines, India and a growing presence in the Czech Republic.

Given this excellent performance, does Accenture's stock price have more room to grow?

Key Drivers
First, let's look at the key drivers for Accenture. Often the sales of a project last for several months to many years. As a result, new bookings and its book to bill ratio are great ways to monitor the future business of Accenture. For the most recent six months, Accenture had a book to bill ratio of 1.19 to 1. For the February 2007 quarter, new bookings grew by 23 % to $5.33 billion, while revenue for the quarter grew 16% to $4.75 billion. Consulting's bookings were $2.83 billion, up 21%, and outsourcing was up 26% with $1.92 billion in new bookings.

Utilization, the time Accenture's consultants and project people spend working on client assignments, was a very good 89%, the 15th straight quarter this key factor has been above 80%. This is excellent, since normally these firms do not tend to bill for training, vacation, administration activities, down time, firm meetings etc. However, many outsourcing contracts may include some of this time in the agreement, which would help account for the high rate. Also, its IT development centers are clearly contributing to this higher utilization.

Accenture's industry focus is also contributing to its success, especially its Financial Services, Products and Resources industry groups. This expertise allows the firm to charge higher billable rates for the services it delivers, increasing its margins.

In short, Accenture is doing well across all of its business activities. So, the big question is whether the stock is fairly valued, considering its recent performance and expectations for the future?

Quick Stock Price Assessment
There are several ways to approach determining Accenture's fair value. One of the most basic is to use the current P/E ratio and then forecast the company's earnings. For the trailing twelve months Accenture earned $2.05 per share. This includes about six cents per share of non-recurring benefits for reorganization improvements, resulting in real earnings of $1.99 per share. The closing price on April 26, 2007 was 38.72, resulting in a P/E ratio of 19.5.

Management's guidance for the remainder of the fiscal year is for earnings to be in the in the range of $1.88 to $1.93. Using the high-end of its guidance and a P/E ratio of 19.5 give us an expected stock price of 37.64. Usually management, being conservative, will guide lower so when they report, they can beat their guidance. So, let's assume this is the case, and earnings will grow in line with recent revenue growth of about 15%. This gives us potential earnings per share of $2.29. Applying the 19.5 P/E ratio generates an expected price of $44.66 per share. Keep in mind that this share price is substantially higher than management's guidance. So now we have a price range of 37.64 to 44.66 for Accenture over the next 10 to 12 months.

Fair Valuation
To help determine the fair value of Accenture's stock, it is useful to look at the P/E ratios of comparable companies, such as Computer Science Corporation (NYSE: CSC) and Electronic Data Systems Corporation (NYSE: EDS). In both cases these companies sport substantially higher P/Es with Computer Science's at 28 and 33.6 for Electronic Data Systems. A brief look at both of these companies reveals that neither is growing faster than Accenture.

So, it is possible Accenture could experience some P/E expansion as the market realizes the potential of the firm and the stock price catches up with its peers. Let's say the P/E ratio in 12 months is half-way between CSC's 28 and Accenture's current P/E of 19.5, somewhere in the 23 to 24 range. In this case, Accenture could see its share price reach $46 ($1.93 x 24). If earnings were to grow to the mid-point of management's guidance and the 15% growth rate mentioned above, then we could see a price close to the $50 area ($2.11 x24).

It seems that Accenture could see a nice increase in the price of its shares if it is able to sustain its current, new-business generation causing an expansion in its P/E. Regarding down-side risk, its current P/E should give it some protection from further price decline, as long as its business does not reverse course.

Conclusion
Investors considering buying Accenture should carefully examine whether the company is valued fairly and if they believe in management's guidance. The firm might be considered a "value play" by some measures, offering the potential share-price appreciation over the next year. Of course, if revenue growth was to slow and management's guidance turned out to be too optimistic, then all bets are off.

However, Accenture offers an interesting opportunity for value investors, especially if one can get an entry price on a dip in the share price.

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