Second Half Critical For TechnologyOne

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

TechnologyOne has guided to FY18 profit growth of 10-15%, which suggests a substantial turnaround is required in its consulting division.

-Improved profitability in cloud business offset by increased losses in the UK
-Much stronger second half expected in consulting business
-May consider a special dividend at the end of FY18
 

By Eva Brocklehurst

Software provider TechnologyOne ((TNE)) continues to be affected in its earnings results by the timing of deals, once again stating that its first half is not indicative of the full year.

Hence, brokers concentrate on the outlook for the full year result and the company provided FY18 guidance of 10-15% growth, which implies a relatively flat outcome versus the underlying FY17 result.

Growth in software licence fees, a leading indicator for the business, was the highlight for Bell Potter, up 7% in the half year The broker is disappointed nonetheless, given improving profitability in the cloud/SaaS business has been offset by increased losses in the UK business and only a modest rebound in consulting.

UBS agrees full year guidance suggests a substantial turnaround is required in consulting. The broker also requires greater evidence of stabilisation across the consulting and UK businesses before taking a more positive view.

An operating earnings margin of 10.3% compared with 10.7% in the prior corresponding half. Initial licence fees of $26m were up 7% while annual licence fees were up 6%. Consulting services business was down -9% while cloud service fees were up 63%. Recurring revenue now comprises 55% of the total.

Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, downgrades EPS forecasts on FY18 and FY19 by -4% and -7% respectively. Forecasts for FY18 are now consistent with guidance and pre-tax profit growth of 14% is expected. The broker, maintains a Buy rating and $5.60 target.

The negative surprise on the result was another modest loss in consulting. The company does suggest pre-tax profit of around $7m in FY18 for this division, which implies a much stronger second half.

The positive surprise was the result in the cloud, supported by a better-than-expected margin, at 25.0% versus 13.5%. The company is targeting a margin of 30% for the cloud business, which it expects to achieve in the next few years.

Morgans remains conscious technology companies, in general, are trading at elevated multiples. Hence, changes in interest rates and/or investor sentiment could swing the view back the other way. The company will provide details regarding the impact of accounting policy changes in July 2018. These are expected to have an impact 18 months from now.

Valuation

Morgans frames both sides of the argument regarding the valuation. TechnologyOne is a high-quality business but its profit growth is not as high as peers, so it becomes debatable whether the stock should trade on an equally high multiple.

Conversely, the company has substantial and growing recurring revenue that is higher quality than peers, so perhaps it should trade on a higher multiple because of its higher-quality earnings stream.

The company has indicated it will consider a special dividend in the full year results.

FNArena's database shows two Hold ratings and one Buy (Macquarie, yet to update on the result). The consensus target is $5.27, suggesting 16.3% upside to the last share price.

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