Positive Accents for Accenture


By Stephanie Crane Business is looking good for Accenture (ACN

; recent price, $26), the big consulting and outsourcing concern formed by the restructuring of Arthur Andersen. The outfit had a strong showing in the fiscal first quarter. Its top line is growing, and the outlook for demand is better than expected. We also see the beginning of a recovery in spending on consulting services and greater momentum towards small to midsize contracts with shorter cycle times. And pricing and employee attrition are showing signs of stabilization, alleviating some stress on profit margins.

Given those favorable conditions, on Jan. 7 we upgraded our recommendation on Accenture shares to 4 STARS (buy), from 3 STARS (hold). Our 12-month target price was also raised to $30, based on a price-to-sales multiple of 1.7 times estimated sales in fiscal 2005 (August) and a p-e multiple of 19 times our fiscal 2006 earnings-per-share projection of $1.55.

CHALLENGES AHEAD. Accenture is one of the largest global consultants, deriving 64% of its sales from consulting. The rest come from outsourcing. It's particularly strong in India, one of the fastest growing markets for offshore outsourcing. Clients include Fortune Global 500 and Fortune 1000 companies, as well as midsize enterprises and government entities. In fiscal 2004, 45% of sales came from the Americas, 48% from Europe, the Middle East and Africa, and 7% from Asia Pacific.

The company does face some challenges, creating risk to our recommendation and target price. They include the possibility of increased competition in the IT services and business-process outsourcing markets, leading to potential pricing pressures that could hurt profit margins. Sales-force compensation is rising, as is attrition. A shift towards emerging markets also creates a risk for the company.

Growth is strong, though. Net revenues (revenues before reimbursements) for the first quarter of fiscal 2005 reached $3.73 billion, up 14% year over year in U.S dollars and up 9% in local currency. Diluted earnings per share were 32 cents, 1 cent ahead of the consultant's prior guidance range of 28 cents to 31 cents and 1 cent ahead of our expectations.

FIRMING PRICES. Marked strength is also evident in all Accenture's business segments. All five posted double-digit growth, led by the financing and product groups, which grew 25% and 23%, respectively. We believe the outfit benefits from diversification within its segments, allowing it to offset adverse impact from negative market movements. Consulting and outsourcing also increased in double digits, which we view as a welcome change after more lackluster results in the prior year.

On a global basis, sales grew 24% in Europe, the Middle East, and Africa (EMEA) and 23% in Asia Pacific, with a more moderate 3% increase in the Americas. We expect a more concerted effort by Accenture towards sales in the Americas in the next three quarters, likely serving as a driver for near-term growth.

Pricing is showing some evidence of improving for both the consulting and outsourcing business, along with a pick-up in demand. Contracts booked for the year and in the pipeline have increased, with a shift evident towards small to midsize deals. We see the shift in size and the quicker turnover in contract cycle time as very positive for Accenture's top line and margins, particularly as the risks associated with timing related to recognizing revenues are minimized.

FAVORABLE CURRENCY TRANSLATION. However, as demand has increased, the consultant noted several staffing inefficiencies, forcing a redirection of resources to increase hiring efforts in key markets, namely the U.S., where increasing sales from consulting is a corporate goal. Attrition has stabilized at around 20%, although the corporate goal remains in the mid-teens.

Accenture was formed in 1989 by a group that included some former partners of Arthur Andersen. While the two partnerships had a contractual relationship, they were legally separate entities. Accenture went public in 2001. The consultant uses its extensive knowledge of industries and business processes to help clients identify new business and technology trends and to formulate and implement solutions to boost revenue, enter new markets, and deliver products and services more efficiently.

The communications and high tech group is the largest, contributing 27% of revenue in fiscal 2004. Growth came from large outsourcing contracts and favorable currency translation, as well as a big communications deal in North America. The group includes the communications, electronics, and high tech markets, and media and entertainment. Services aimed at solutions in these markets include mobile technology applications, network optimization, broadband and Internet protocol solutions. The other business groups include financial services, general products, government and resources.

FATTENING MARGINS. We expect net revenues to increase 11% in fiscal 2005, to $15.1 billion, following a 13% increase in fiscal 2004. We see growing demand for IT outsourcing, consulting, and business processing outsourcing (BPO), areas in which we expect an accelerated recovery as enterprise-based capital expenditures rebound. We think that Accenture's aggressive efforts in the BPO field in the U.S. and Europe should begin to show positive results.

Gross margins are expected to widen to 32% in fiscal 2005, from the 31% level in fiscal 2004. We think that restructuring, better pricing initiatives, and more aggressive management of the outsourcing and consulting portfolio will add leverage to sales growth. We expect operating margins to continue in the mid-teens on more effective efforts to minimize selling, general, and administrative (SG&A) costs.

Net income will likely hit $1.3 billion for fiscal 2005 and earnings per share, $1.37. This compares with net income of $1.17 billion in fiscal 2004 and earnings per share of $1.22. Our Standard & Poor's Core Earnings projection for fiscal 2005 is $1.27 a share, reflecting estimated stock-option expense.

CAPITAL SPENDING BOOST. Our 12-month target price of $30 is based on a historical price-to-sales multiple of 1.7 times applied to our fiscal 2005 revenue estimate. We also compared the shares with those of a peer group of IT services competitors in terms of relative multiple analysis, which includes price to earnings.

Our buy recommendation on Accenture shares is based on valuation as well as signs of improvement in the global consulting and outsourcing markets. The number of small to midsize contracts in the pipeline has increased, exhibiting shorter lead times. Pricing is also stabilizing, and the company is seeing less attrition within its employees. We expect some p-e multiple expansion from current levels, as we see capital expenditures accelerating thanks to an improving economic environment, rising demand for solutions. Furthermore, the company is likely to continue benefiting from operating leverage and embedded efficiencies.

Note: Stephanie Crane has no stock ownership or financial interest in any of the companies in her coverage area. All of the views expressed accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com Analyst Crane follows technology outsourcing companies for Standard & Poor's Equity Research


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