Technology One On Course For Profit Growth

This story features TECHNOLOGY ONE LIMITED. For more info SHARE ANALYSIS: TNE

A delay in finalising some consulting contracts has led Technology One to downgrade FY17 profit forecasts but brokers observe the business continues to perform well.

-Several negative effects converge to cause downgrade, likely one-offs
-Stock has re-rated substantially and could be vulnerable to a change in sentiment
 

By Eva Brocklehurst

Technology One ((TNE)) may have issued its second downgrade to 2017 expectations but brokers are not overly concerned. Pre-tax profit growth of 7-9% is now forecast, versus prior guidance of 10-15%.

The main reason for the revision to the prior guidance is that there's been a delay in the number of deals being finalised where the company is a preferred contractor. These contracts have not been lost but the revenue just pushed out into 2018.

The company now expects consulting profit of $5.4m in 2017. Underlying growth of around 20%, in Macquarie's calculation, highlights the fact the business is still performing well. A significant turnaround is expected in 2018 and the company's software offering continues to appeal to more customers, as corporations realise the benefits in moving away from customised software and on-premises systems where possible.

Macquarie expects significant improvements in performance and efficiency, as the company has separated its consulting business into two business units, one for new customers and the other for existing customers. Sales are heavily weighted to the second half, with 82% of net profit expected to be generated in second half of 2017.

Bell Potter downgrades forecasts for earnings per share in 2017 and 2018 by -6% and -4% respectively. The broker now forecasts pre-tax profit growth in 2017 of 8.5%.

Forecasts for strong pre-tax profit growth of over 20% are maintained for both 2018 and 2019. The main drivers are improved profitability in both the cloud and UK businesses and growth in licence fees.

Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, rejigs its modelling and the net result is a -4% decrease in the target to $5.50 from $5.75, a 21% premium to the prevailing share price. As a result, this warrants an increase in the recommendation and the broker upgrades to Buy from Hold.

Had three significant events not all occurred in 2017, then Morgans agrees profit growth would have been closer to 20%. The negatives were the Brisbane City Council dispute costs, higher-than-expected Evolve costs and delays in the consulting business contracts.

The broker notes, typically, the company's portfolio offers a more balanced outcome as one part underperforms and another outperforms, netting each other out. Morgans reduces forecasts for earnings per share by -6-10% and now reduces 2018 forecasts to be closer to 10% growth in earnings per share.

The broker takes a view that this is a one-off downgrade although acknowledges others may be concerned "as downgrades typically happen in threes". The broker reduces its target to $4.16 from $5.69 and retains a Hold rating. Morgans judges the business to be high-quality, given the relatively defensive earnings, long-term track record and impressive financials.

Still, the trading multiple over the last five years has re-rated to more than 30x price/earnings from an historical average of 15x price/earnings, and Morgans is acutely aware that a change in interest rates and/or investor sentiment could instigate a de-rating, noting that the company has not meaningfully downgraded earnings expectations since the GFC in 2007 and this has, possibly, led investors to forget that nothing is guaranteed.

FNArena's database shows one Buy rating (Macquarie) and two Hold. The consensus target is $5.20, suggesting 14.2% upside to the last share price. This compares with $5.92 ahead of the announcement. Targets range from $4.16 (Morgans) to $5.75 (UBS, yet to update on the announcement).
 

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