Australia | May 02 2012
– SAI shares hammered after profit warning
– Three brokers downgrade ratings
– Just a flesh wound, say others
– double-digit growth on offer in FY13
By Greg Peel
“Where there is one there is usually three,” suggests Citi, rather ominously, in a report this morning. The truth of the matter is Citi is drawing on plenty of past examples.
The Citi analysts were prompted to provide the warning after yesterday's profit downgrade from SAI Global ((SAI)) – the second in three months. What is most disappointing for many brokers is that the second downgrade has come so soon after the company's interim result release in February. Citi has downgraded its rating on SAI to Hold (Neutral), joining two other FNArena database brokers in doing the same. The market took SAI shares down yesterday by 5% after the announcement and another 6% has been lost so far today in the wake of the broker downgrades.
The question is now as to whether SAI might be a good buying opportunity. Although on Citi's warning, there's another profit downgrade to come.
SAI Global engages in providing information services and solutions for managing risk, achieving compliance, and driving business enhancement worldwide through a wide and diverse range of services. The company's earnings have to date been considered to be of a defensive quality, and with new contracts due to impact on the bottom line next year, SAI had been boasting a clean sweep, eight out of eight Buy ratings in the FNArena database. Until today.
SAI yesterday issued new guidance which amounts to an FY12 profit downgrade of up to 9%. The reasons behind the downgrade are both macro-related and company-specific, JP Morgan notes, with Information Services and Compliance Services divisions the key culprits due to weaker trading conditions, infrastructure set-up costs, rationalisation of legacy contracts and product development issues. JPM points out that while SAI has “attracted followers” due to its defensive characteristics, the downgrade shows the company is not immune to macro issues, or its own problems.
At the release of the first half result, management had declared expectations that the Standards business would improve in the second half but this hasn't happened given weakness in Europe and in Australia, Citi notes. Compliance sales continue to lag thanks to a slow uptake of UK bribery legislation solutions. Given the heavy infrastructure build undertaken to market this product, the slow take-up is disappointing and quite damaging to margins. The products may take longer to gain traction than first thought, RBS suggests. While higher costs form part of the downgrade, RBS believes the drop in guidance reflects “new negatives related to revenues” and not just costs.
Deutsche Bank nevertheless believes the market has missed an important announcement buried within the guidance announcement yesterday in its rush to exit the stock. Part of the downgrade came from increased costs in starting up new mortgage processing work but SAI has also now signed a second mortgage processing contract. And SAI has also made a small acquisition in the form of a seafood standards and supply chain management system.
“We see the trading disappointment as a temporary setback,” says UBS. Mind you, the earlier downgrade at the February result was dismissed by the brokers in the same vein, including Citi, which is why those analysts now have the heebie-geebies. Citi nevertheless still expects SAI's earnings to grow by 20% in FY13 with the significant new contribution from the ANZ property services contract. And therein lies the crux of SAI broker recommendations.
RBS is expecting 18% earnings growth in FY13, Macquarie 19%, Deutsche Bank 24%, and JP Morgan sees a 30% increase in profit. UBS suggests costs incurred in Property Settlement and Compliance in FY12 should be recouped from sales in FY13, and notes the increased enforcement of the Foreign Corrupt Practises and UK Bribery Act provides a tailwind despite the sluggish start for that new product. Credit Suisse notes the large Property and Assurance businesses are continuing to deliver upon expectations through a difficult economic environment and thus “the rationale for investing in SAI remains largely unchanged”.
Macquarie notes SAI is in advanced discussions with a number of the major banks regarding further contract opportunities and the broker retains SAI among its “preferred picks” in the emerging leaders group.
All brokers have today cut back earnings forecasts, with a couple of the downgraders also taking a knife to FY13. SAI's consensus target in the database has fallen to $5.34 from $5.56 which at today's trading levels suggests around 13% upside. From eight out of eight, SAI now has five Buys and three Holds.
SAI's business amounts to complex IT solutions. Cost overruns and delays are part of the game. Macquarie is attracted to SAI's growth prospects as the company grows its global footprint while UBS notes SAI boasts a leading global position in a highly scalable business with low working capital requirements and high barriers to entry.
Is this just a stumble along the way to much greater things, or will Citi's warning prove accurate? SAI Global does not pay a big yield but if the Buy-raters are right there may be room to improve on solid earnings growth. And the share price has been hammered for two days.
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