Small Caps | Dec 18 2013
-Strong growth in key contracts
-Management seen reducing risk
-Doubling of earnings, div seen in FY14
By Eva Brocklehurst
IT services provider Empired ((EPD)) is not just a consulting company but a software engineer providing business solutions. This means a large percentage of revenue comes from multi-year managed services and higher margin projects, for the energy and natural resources sector as well as state governments.
This focus has made the stock stand out for Bell Potter. What makes this company special is that it has two very substantial contracts, which support revenue growth projections of 69% in FY14 and 23% in FY15. Despite the large size of this forecast increase Bell Potter is confident that it can happen, with a significant skew to the second half in FY14. As the growth is predicated on existing contracts, any more contract wins will deliver further upside. Bell Potter also likes the higher barriers to entry in the company's markets.
So what is it about these two contracts that's so exciting? The biggest, in terms of value, is with a major resources company for a mining system upgrade. This is a $30m contract over three years with potential for $50m over five years. The other is of similar value with Western Australia's Main Roads department. This contract is for an initial $28m over three years with potential to grow to $46m over five years.
The other aspect that pleases the broker is that the company is well aware of execution risk, given such large increases in revenue are predicated on just two contracts, and has taken steps to mitigate this. The major mining system upgrade is divided into components, which range in size between $2m and $6m. Moreover, Empired is paid for successful delivery of each component and doesn't take on the risk of reconciliation or integration of the components.
At Main Roads the contract is on an open book basis, reducing the risk by taking a cost-plus approach. While the margin is lower than for a typical infrastructure project the risk is also lower. All up, this provides the broker with some assurance that the earnings margins can be achieved and revenue forecasts can be met.
The major risk, of course, would be loss of a key customer. Main Roads is currently the largest and accounted for 15.5% of revenue in FY13, so if it were lost it would have a material negative impact. This percentage will reduce to 11% in FY14 and to 10% in FY15. Empired recently acquired Melbourne-based systems consultant, OBS, and that company is expected to generate FY14 revenue of $32m, representing around 31% of the broker's total revenue forecast. The risk here is that any shortfall could have a material impact.
Bell Potter retains a Buy recommendation and 92c price target. The price target is at a 46% premium to the current share price and the broker's total expected return on the investment, including dividend yield, is 47%. On the back of a forecast doubling of earnings in FY14 Bell Potter also expects the dividend will double in FY15 and FY16, to 1c and 2c respectively.
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