Small Caps | Sep 06 2018
Software company Citadel Group beat most estimates in FY18 and has reiterated a goal for growth of 15% in operating earnings going forward.
-Main competitive advantage is 100%-owned IP for critical operations
-Strong track record of delivering and renewing contracts
-Downside risk centres on lack of clarity around contracts
By Eva Brocklehurst
Software company Citadel Group ((CGL)), which specialises in managing information in complex environments for both state and federal government departments, has a buoyant outlook. The majority of the company's revenue is derived from long-term managed services contract and high-quality strategic advisory services.
FY18 results beat most estimates, primarily, Wilsons believes, because of improved resource allocation within major projects. The company has provided no guidance other than to reiterate a goal of growth of 15% in operating earnings (EBITDA).
Growth in FY18 was derived from a combination of Citadel Health, the federal agency contract, and positive contributions from Monash and Kapish. The company's main competitive advantage is its 100%-owned and developed intellectual property that is used to run critical operations. The company also has the intellectual capital to design, integrate and deploy enterprise solutions.
Wilsons found the outlook statement in relation to new work very positive as 60% of the $800m contract pipeline is related to software-as-a-service. Yet, the broker downgrades to Hold, with a target of $7.40, noting the stock has closed the valuation gap relative to domestic and international technology peers and the market is now assigning fair value to the shares.
Operating cash flow in FY18 was below Bell Potter's forecasts, largely because of a delay in milestone billing on a large program. The broker flags the confidence in the outlook for FY19, with Citadel emphasising a large number of opportunities for leveraging new products.
Bell Potter upgrades FY19 and FY20 forecasts by 16% and 14% respectively. These upgrades are driven by increases in margin forecasts. The broker maintains a Buy rating and $8.50 target. Dividend forecasts for FY19 and FY20 are retained, given pay-out ratios are broadly consistent with FY18. The company is expected to continue making acquisitions and therefore the broker believes a pay-out ratio of around or just under 50% is appropriate.
The main risks brokers envisage are losses of one or more of key contracts that could have an adverse impact on the financial performance of the company. However, Citadel has a strong track record of delivering and renewing contracts, and all key contracts are over multiple years.
Bell Potter assumes Citadel is successful in securing one or two new material managed services contracts each year. The company tries to mitigate the risk and disruption from technological advances by investing in development.
Shaw and Partners also has a Buy rating, with an $8.00 target. The broker notes previously delayed contracts materialised in the second half and the benefits of scalability have emerged. Contracts were extended, new work was won and the broker notes good management of costs and higher cross-selling all contributed to a strong beat on estimates.
The broker was also pleased with the growth in gross margin, despite the fact it was below forecasts because of further investment in new software. Shaw and Partners envisages double-digit earnings growth over the next three years, return on equity improving to over 20% and positive free cash flow. Any downside risk centres on the lack of clarity around contracts.
Shaw and Partners advises that Citadel Group is not the easiest company to understand but has had a solid performance over the past year and retains attractive metrics. The company has a unique product and service offering such as e-Blood for managing blood products through the health system, Charm, used in oncology, and Auscare for clinical work.
The intellectual capital used to design, integrate and deploy solutions includes secure videoconferencing, hospital unified communication, and counter terrorism services such as facial recognition. The company also runs the largest Australian-based laboratory information system, supporting over 34 laboratories.
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