Australia | Nov 25 2020
This story features TECHNOLOGY ONE LIMITED. For more info SHARE ANALYSIS: TNE
TechnologyOne provided a solid performance over FY20, despite the pandemic and extra provisioning, although several brokers remain wary of valuation
-Has the inflection point in cloud conversion arrived?
-Reaffirmed strength in government, education software
-UK reaches break even
By Eva Brocklehurst
Cash flow, strong cost controls and profit margins stood out in FY20 as TechnologyOne ((TNE)) performed impressively despite the impact of the pandemic and the need to take extra provisioning.
The business has evolved as software-as-a-service (SaaS) and Morgans assesses the transformation period is almost over. Legacy revenue declined -34% and double-digit revenue growth should start to be more apparent in the next several years.
Morgans was impressed with the results given the damage from the pandemic, calculating that after including rental expenses, free cash flow was $54.2m or 82% of normalised net profit. Revenue growth of 4% may appear weak but the broker suspects this is a function of the transition to SaaS. In contrast, at $58.7m free cash flow was up 52% for the year.
In FY20 around 70% of total revenue was recurring and, classing consulting in this way, Morgans calculates 90% of revenue is now recurring. Shaw and Partners agrees the inflection point has finally arrived, and without the pandemic the results may have been even better.
Reported pre-tax profit rose 8% to $82.5m in FY20, at the lower end of the guidance range, as TechnologyOne found it necessary to make a rare downgrade in October after a court ruled adversely in a case brought by a former employee.
Yet, profit margins were a highlight, rising to 27.6%. A final dividend of 9.41c was declared. No specific guidance was provided but the company did indicate it expects further strong profit growth in FY21.
Macquarie also hails strong cost control, noting second half operating expenditure was down -19% half-on-half. Employee costs were down -11% while capitalised R&D increased to $37.1m. The education vertical held up better than feared and Macquarie flags commentary regarding a robust tender outlook.
Wilsons considers the results have reaffirmed the nature of the company's "mission-critical" software for education, government and local councils. The company has a track record of meeting or beating guidance and the migration to the cloud remains intact, only slowing modestly.
Given the resilience of the government sector over the last 18 months, Wilsons is confident TechnologyOne will continue to capture its share of opportunities. Around 86% of FY21 revenue is already contracted.
UBS also highlights momentum in federal government business, an area which can be improved given TechnologyOne has a lower penetration compared with the local government and education sectors.
TechnologyOne did draw out its recurring revenue target of $500m, to FY26 from FY24. This was the main detractor in the results for several brokers, given most businesses have rapidly adopted the cloud and SaaS.
Morgans suspects the company is taking a conservative stance while Shaw considers the revenue profile is now more achievable. TechnologyOne has replaced references to doubling gross profit every 4-5 year with doubling every five years, which implies average growth of 15% as opposed to 15-19%.
The UK reached break even and there were nine new customers gained, although Morgans points out revenue needs to accelerate to cover the $11m in expenses in the UK on a sustainable basis.
Still, management is confident that after more than a decade of generating losses, UK profitability is finally sustainable. One caveat, the broker suspects, is any need for further reinvestment.
All up, TechnologyOne is robust, although Morgans is conscious that technology companies in general are trading on elevated multiples. This could occur for some time, given the prevailing low interest-rate environment.
The broker observes that, with coronavirus vaccines expected to boost global economic growth, this is resulting in a rotation to cyclical stocks from technology-centric growth stocks. Should this become a longer trend it could result in downside risk to the share price and multiples.
Moreover, Morgans warns that investors need to be aware that changes to interest rates and/or investor sentiment swing the pendulum materially for valuing growth stocks, and this is the main risk for TechnologyOne.
Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, believes much of the fundamental upside is priced in and retains a Market Weight rating with a $9.37 target while Bell Potter, with a $10 target, downgrades to Hold from Buy on valuation. Shaw and Partners, also not one of the seven, retains its Buy rating and $9.76 target.
The database has one Buy rating (Morgans), one Hold (Macquarie) and one Sell (UBS). The consensus target is $9.20, suggesting 1.7% upside to the last share price.
See also, Treasure Chest: TechnologyOne Stumbles on October 6 2020.
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