Australia | Aug 11 2011
– Oakton result weak but well flagged
– Victorian operations showing signs of improvement
– Potential for further improvement makes Oakton a turnaround story
– Ratings upgraded to reflect potential upside
By Chris Shaw
IT group Oakton ((OKN)) delivered what was generally regarded as a weak full year earnings result, the result in itself no surprise given such an outcome had been well flagged by management.
New information in the result, according to RBS Australia, was the progress being made in turning around Oakton's Victorian operations. Key metrics for that division have all improved, with staff churn falling and utilisation and sales conversion all rising.
The latter was helped by two new clients being secured in the June half. This suggests to RBS while there is more work to do, the Victorian operations appear to have reached a turning point with further improvement expected going forward.
Goldman Sachs agrees the Victorian business still needs to improve, noting while utilisation rates improved in 4Q11 in particular, more outcome-based work needs to be secured. As Goldman Sachs notes, this form of work currently accounts for 54% of sales against management's target of 70%.
The other major positive for Oakton according to Macquarie is the removal of the Tenix legal case overhang, that matter having recently been settled. This will free up both management and billable staff, as six staff members were working full time on the case.
The Tenix settlement was certainly not a positive for the Oakton share price, Goldman Sachs noting the stock has lost 27% since settling the case. On the flip side, the settlement has returned Oakton to a net cash position of around $10 million. This should allow for an increase in dividend payout ratio from the 61% recorded in FY11 to 70-80% in FY12.
Looking to the future, management at Oakton has guided to FY12 sales growth of 5-10% on headcount growth of 4-6%. Margins are also expected to improve by 100-200 basis points, so driving stronger earnings growth in the view of Goldman Sachs.
To reflect both the FY11 result and the latest guidance from management, brokers across the market have adjusted earnings estimates for Oakton. Goldman Sachs has lowered its earnings per share (EPS) estimates by 8-9% for FY12 and FY13, while Macquarie has trimmed FY12 numbers by 1% but lifted FY13 estimates by 5%.
Consensus EPS forecasts for Oakton according to the FNArena database now stand at 20.5c for FY12 and 23.4c for FY13, which compares to the 18c earned in FY11.
Macquarie notes the growth expected in FY12 depends in good part on further gains in the Victorian operations, so there is some risk. There is also solid potential, as had Oakton delivered a flat result in Victoria in FY11 group earnings would have been $7 million higher.
Following the recent weakness in the Oakton share price the stock is now trading on an earnings multiple for FY12 of around 9.4 times on Macquarie's numbers. At this level the broker suggests downside risk to earnings is largely factored into the share price, while there is also growing dividend yield support given an expected higher payout ratio. Oakton is forecast to yield better than 8.0% fully franked in FY12.
This is enough for Macquarie to see good turnaround potential and so upgrade to an Outperform rating from Neutral previously. Others have followed suit, as both RBS Australia and Credit Suisse have upgraded to Buy ratings for the same reason – an attractive risk/reward profile at current levels.
Goldman Sachs has similarly upgraded to a Buy rating, this despite an 18% decrease in price target to $2.44. The fall in target reflects a collapse in market multiples given recent weakness in the market generally.
The upgrades to ratings means aside from the Buy rating of Goldman Sachs, Oakton is now rated as Buy by all five brokers in the FNArena database to cover the stock. The database shows a consensus price target of $2.35, down slightly from $2.52 prior to the profit result.
Shares in Oakton today are down slightly and as at 11.30am the stock was 2c lower at $1.885. This compares to a trading range over the past year of $1.60 to $3.20. The current share price implies upside of around 20% to the consensus price target in the FNArena database.
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