Healthier IT Markets Helping Accenture

By Stephen D. Simpson, CFA | March 26, 2012 AAA

Outsourcing may still get a bad rap, but the fact remains that it's a major growth market around the world today, and Accenture (NYSE:ACN) continues to reap the benefits. At the same time, the company is hardly suffering in its consulting business. While the market has caught on to some of the value in this story, investors should yet expect to see further gains from this stock.

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Good Second Quarter Numbers
Accenture reported that revenue grew 12% as reported or 13% in local currency. Outsourcing was again the growth leader, as revenue rose 19%. Consulting was a laggard, but still saw top-line growth of 8%. Revenue in the core Americas region climbed 13%, and the company saw solid growth across its addressed industry groups.

Profitability was likewise solid. Although gross margin eased a bit (down 60 bp), operating income rose 15% as the company spent less (as a percentage of revenue) on both sales/marketing and corporate expenses.

Mixed Messages in The Bookings
On the whole, the company's bookings numbers were decent. Outsourcing bookings rose 8% and the company produced a very solid 1.29 book-to-bill. Consulting was less impressive, as bookings fell 4% from last year, but the book-to-bill was still positive at 1.07.

The strength in outsourcing is not surprising. While it's not widely popular, the reality is that people say one thing and do another - customers reliably go with low-cost providers and outsourcing is one of the best (or at least easiest) ways for enterprises to reduce costs. Though Accenture does have some challenges in competing with lower cost providers like Cognizant (Nasdaq:CTSH), Infosys (Nasdaq:INFY) and Tata Consultancy, particularly in recruiting/retaining employees overseas, Accenture is nevertheless more than holding its own here.

Consulting Still a Long-Term Honey Pot
Accenture's outsourcing business is certainly important, but I believe the consulting business is the more valuable asset (or at least the asset that's harder for a competitor to replicate). Accenture benefits from having a deep talent pool across its industry silos, and its leadership tends to be pulled from long-time employees - a circumstance that perpetuates a differentiated culture. At the bottom line, this makes Accenture a gold-star option in consulting, alongside IBM (NYSE:IBM), and that's a non-quantitative factor that really supports a lot of Accenture's value.

That said, there's at least one downside to Accenture's consulting business - it doesn't carry the same strong margins. Outsourcing is about producing comparable results at lower costs, but consulting is simply a more expensive service to provide, given the expertise and value of the employees involved. That said, while Accenture doesn't stack up as well as the Indian outsourcing specialists in terms of margins, the differences in returns on capital are less pronounced.

The Bottom Line
Oracle
's (Nasdaq:ORCL) recent results are encouraging with respect to the overall health of the IT market, and Accenture's bookings numbers support the idea that overall market conditions are still pretty healthy.

Accenture may not look all that cheap on the basis of backward-looking multiples, but the cash flow picture is more encouraging. Even if competition (for customers and employees) limits Accenture's ability to significantly boost its free cash flow conversion rate, high single-digit free cash flow growth should be in the cards, and the stock's fair value likely sits north of $80 a share.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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