SMS Management Positively Surprises

This story features SECURITY MATTERS LIMITED. For more info SHARE ANALYSIS: SMX

-Dividend surprises
-Margin expansion potential
-Strong pipeline of work
 

By Eva Brocklehurst

SMS Management & Technology ((SMX)) delivered one of the more upbeat earnings reports of the season, signalling a weak prior year has been cycled. Acquisitions also underpinned the results. Issues surrounding working capital in the first half dissipated in the second half and the full year dividend of 17c was also above forecasts.

The 36% growth in earnings and dividends impressed Morgans. Operating cash flow was up nearly fourfold. Of most significance is the return to organic growth. The broker is now confident the worst is behind the company and upgrades to Add from Hold, believing now is the time to get back on the front foot with the stock.

Change is the only constant in the IT industry, Morgans observes. On this subject, as a business which provides management advice on IT changes, SMS Management's own restructure has been a key selling point. The strategy is to shift the business mix towards managed services and solution development, with potential acquisitions being actively sourced.

A number of changes were made in Victoria, the main driver of earnings but recently a weak area, which now means all geographies are growing. The stock is trading on a price/earnings ratio which is below the market but offers well above market in terms of organic growth on Morgans' estimates. The broker upgrades FY16 and FY17 estimates by 18% and 16% respectively.

There was little wrong with the results, UBS observes. If nit picking, the only item which was amiss was the expected uplift in second half consulting utilisation did not occur, although at 84% it was still an improvement on FY14's 80%.

The company has around 25-30% of its targeted revenue secured for FY16, versus the historical levels of 10-15%. Large opportunities are also observed in the pipeline of work. 

Management has signalled second half margins are a good starting point for FY16 and UBS suspects, with a slight uplift in utilisation and further cost initiatives, margins could well expand further in FY16 and FY17. UBS also upgrades to Buy from Neutral on the back of the results.

Morgan Stanley reiterates an Overweight rating following a result which beat expectations on several fronts. The broker hails the first meaningful upgrade to the outlook after a prolonged down cycle.

Macquarie liked the news too, with margin growth ahead of expectations and a gradual improvement expected as FY16 unfolds. Earnings visibility in the traditional consulting service may be limited but the shift towards managed services provides annuity revenues and gives the broker more confidence in the near-term performance.

The result was improved by $1.8m in forfeited performance rights which were written back into accounts, Macquarie points out. Managed services now account for 10% of revenue and in FY16, short of the 25% target, but the broker suspects the group will attempt to achieve this target through acquisitions in FY16.

Macquarie commends the restructure, where sales teams are divided by industry verticals rather than regions, noting improved margins for the first time since 2011. The broker's valuation is broadly in line with the emerging leaders industrials market and a Neutral rating is retained.

Goldman Sachs, not one of the eight brokers monitored daily on the FNArena database, upgrades earnings estimates by 20-22% but also retains a Neutral rating given the stock's limited visibility and cyclical nature. The broker suspects the changes to the sales structure could still prove disruptive in the short term.

FNArena's database reveals three Buy and one Hold rating. The consensus target is $4.54, suggesting 5.0% upside to the last share price. This compares with $4.04 ahead of the update. The dividend yield on FY16 and FY17 forecasts is 4.7% and 5.1% respectively.
 

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