Does The Market Expect Trouble At Accenture?

By Stephen D. Simpson, CFA | October 03, 2011 AAA

Sometimes, investors should step back and compare the conventional wisdom on a story with what actually seems to be in the price. Accenture (NYSE:ACN) has long been called a Wall Street "darling" as it is arguably the most well-respected name in global consulting and outsourcing. Yet, despite this love and despite the ongoing growth in its core markets, Accenture's current share price does not seem overvalued at all.

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A Surprising Cap to the Year
Accenture ended the year on a strong note. Reported revenue rose 23%, or 14% in local currency, from last year's level and stayed flat on a sequential basis. Growth was pretty consistent across all of the categories - consulting was up 25% annually and down 2% sequentially, while outsourcing was up 21% annually and up 2% sequentially. Across the major market categories, growth was generally in the 20%+ range (except for the health/public service category), though financial services was a little soft on a sequential basis.

Profitability was okay - not a disaster, but below expectation and the company was unable to fully leverage its top-line beat. Gross margin slid on both an annual and sequential comparison, though operating income did grow 29% on an annual basis (and dropped 3% sequentially).

Strong Getting Stronger?
Accenture had a good quarter, and there was even more good news about the future. Not only is the company converting bookings to revenue faster, but bookings are growing very nicely. For the quarter, Accenture reported that total bookings rose 30% (or 21% on a constant currency basis) with 43% year-on-year growth from outsourcing.

On the surface, this should be good news for other service providers like IBM (NYSE:IBM), Infosys (Nasdaq:INFY) and Cognizant (Nasdaq:CTSH) that frequently overlap or compete with Accenture. It could also be a mixed bag for companies like Computer Sciences (NYSE:CSC), Hewlett-Packard (NYSE:HPQ) and Dell (Nasdaq:DELL) - does it encourage investors that disappointing revenue growth trends could be about to improve, or does it simply ratchet up the scrutiny and make the comparables even more difficult?

That said, the 5% sequential decline in financial services revenue could be a yellow flag for IBM as Big Blue gets a larger percentage of revenue from this market than Accenture. That weaker performance also seems to make sense in the context of what hardware companies like NetApp (Nasdaq:NTAP) and Cisco (Nasdaq:CSCO) reported for the prior quarter, and the ongoing commitment from banks to keep a very firm hand on costs.

Mostly Good, Some Bad and a Little Ugly
There is a lot to like about Accenture. The company practically prints money and shares it freely with shareholders. The company also boasts an eye-popping amount of revenue per employee (roughly double the industry standard) and is a leader in high-value on-site services. Better still, albeit not company specific, is the fact that clients have stronger balance sheets these days and that should lend stability to the balance sheet.

On the darker side, those high-value on-site services are also more expensive to provide and that may cap margin leverage. Competition in this industry is fierce and global, and it is worth asking whether the company's recent free cash flow trend shows intensifying price competition and/or the limits of the company's operating leverage.

The Bottom Line
Maybe Accenture doesn't jump out as a cheap stock with a trailing P/E of 17 or a trailing EV/EBITDA above seven. On a discounted free cash flow basis, though, the stock looks very cheap - cheap enough, in fact, to make an analyst wonder exactly how or why it would be so cheap. If Accenture can move its free cash flow margin back up to 12% over the next five years and keep growing revenue at a high single-digit rate, the stock could be undervalued by as much as 50%.

Outsourcing is not going away, and neither is the need for IT integration and a whole host of consulting services that Accenture provides. Moreover, this is a well-respected brand that produces impressive cash flow and returns on capital. Even with the specter of a recession haunting the markets, it's hard to see how Accenture won't be a market-beater over the coming years. (For additional reading, take a look at Earnings: Quality Means Everything.)

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