Brokers Guarded As SMS Management & Technology Restructures

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

-Demand for IT staff strong
-So issues are company specific
-Consulting earnings visibility limited
 

By Eva Brocklehurst

SMS Management & Technology ((SMX)) has surprised the market with a substantial downgrade to its guidance, as sales momentum is halted amidst an organisational restructure. In conjunction, a number of large projects are winding down. Earnings are forecast to be down 15-20% in the first half.

UBS revises forecasts lower and assumes personnel utilisation will fall to 80% before recovering back to 84% in the second half. Management may highlight the strength in its sales pipeline but the broker wants to witness these sales actually occurring before taking a more positive stance.

Demand for information technology professions remains strong, with UBS observing vacancies were up 12% in the year to September. Information technology continues to outperform the broader skilled sector so company-specific issues need to be addressed for the company to unlock the earnings upside.

Macquarie also believes staff utilisation is a key driver of the outlook, given this is a fixed cost in the operating model and revenue weakness typically translates to a material deterioration in earnings. Longer term opportunities exist but a short-term turnaround appears a low prospect.

The broker also notes that, typically, if the company does not secure the bulk of its budgeted revenue by December, full-year earnings guidance is difficult to achieve because of the shut-down over the summer holidays.

Despite recent measures to diversify into managed services, exposure to the more traditional consulting business means visibility, and hence a large proportion of revenue, is limited. Macquarie looks for a gradual improvement in FY16-17.

Morgan Stanley downgrades to Equal-weight from Overweight on the back of the update, envisaging little scope for organic growth. Given current volatility, the prospect of a year without organic growth means the broker considers the stock is fair value.

Acquisitions remain on the cards but, amid delays to projects, the broker reduces earnings estimates by 11-13% in FY16-18. That said, Morgan Stanley still believes the shift to more annuity-style revenues, a focus on smaller customers and developing industry expertise amongst its sales team will pay off in the future.

Canaccord Genuity was also surprised at the toll that the restructure is taking on first half earnings, which will mark the worst half-year performance in over a decade, despite the company completing two highly accretive acquisitions in the past two years.

The broker believes the change in management brings structural issues in terms of staff culture as well as customer responses, but usually takes longer to filter through to earnings. Of note, the broker highlights the shift to a national delivery from a regional model and the movement of work offshore to a facility in Manila.

Canaccord Genuity, not one of the eight broker's monitored daily on the FNArena database, awaits confirmation of the success of the restructure before becoming more positive and retains a Hold rating with a $3.25 target. Goldman Sachs is in the same camp with its Neutral rating and $3.45 target, materially reducing forecasts for sales by 14-15% and cutting earnings estimates by 35% for FY16.

FNArena's database contains one Buy rating and three Hold. The consensus target is $4.06, signalling 21.3% upside to the last share price. The dividend yield on FY16 an FY17 estimates is 5.2% and 6.0% respectively.
 

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