Technology One To Regain Momentum

This story features TECHNOLOGY ONE LIMITED. For more info SHARE ANALYSIS: TNE

Despite FY17 being beset by costs, Technology One expects profit growth to regain momentum in FY18.

-Company confident event costs are isolated
-Transition to the cloud a key driver of future growth
-Could be still at risk of a de-rating
 

By Eva Brocklehurst

For the first time in ten years Technology One ((TNE)) did not posted double-digit growth in earnings. FY17 net profit was up 8%, unexpectedly affected by costs. Three significant items, all negative, dragged profit lower, but this was flagged prior to the results and therefore of no surprise to brokers.

The items included the Brisbane City Council contract, higher Evolve/conference costs and weaker consulting profits. Steps have now been taken to rectify the issues and contributions from other products should help deliver a strong FY18. Setting aside one-off costs, underlying profit growth was 22%.

The company expects strong profit growth to continue in FY18, targeting pre-tax profit margins of 25% in the next few years. Profit growth is expected to return to historical averages of around 14%.

Earnings will be skewed more than usual to the second half as a significant number of deals that occurred in the prior corresponding half will not be repeated.

The value proposition suggests to UBS there is a robust medium-term growth platform and upside risks if consulting can return to 20% margins in the medium term. Still, execution is the key and further evidence is required to support expectations. The stock appears marginally expensive relative to peers based on the broker's compilation of quality, high-growth ASX300 stocks.

The company believes there is significant upside if it can turn around its consulting division. Weakness was attributed to a number of items, including poor internal controls. UK profits retreated but Morgans understands part of this relates to the consulting business. The company expects the UK to contribute a $500,000 loss on FY18 and break even in FY19.

BCC/Evolve

The company is confident that Brisbane City Council and Evolve event costs are isolated and consulting will improve. The BCC case has been handed over to insurers and the company does not expect any further liability that will affect future results. As a result, Morgans upgrades forecasts to allow for 14% growth in earnings per share.

Cloud

The annualised contract value of cloud business continues to grow strongly, up 69% in FY17, and is expected to reach $42m in FY18. Transition to the cloud should be a key driver of future growth for the company, in Macquarie's opinion, as more customers realise the benefits of moving away from customised software and systems housed on premises.

The highlight for Bell Potter was a 10% growth in software licence fees. Cloud service fees also grew by 84%. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, maintains a Buy rating with a $6.20 target.

The company has indicated it has less than 15% market share in any one segment, so there is opportunity to grow and at the same time manage costs. There was no further guidance and the company will provide more detail at its AGM in February. Morgans expects something similar to the usual 10-15% profit growth forecast, noting a weaker first half is mostly the case.

While investors appear to be taking a view that the recent earnings downgrade was a one-off event, Morgans considers the trading multiple still at more risk of a de-rating than otherwise, and maintains a Hold rating.

The stock is a high quality business that has relatively defensive earnings but its trading multiple over the last five years has re-rated substantially and Morgans warns that sentiment in technology can change or unwind rapidly.

Macquarie expects a return to double digit net profit growth in FY18, supported by momentum in the cloud segment, improvement in consulting and strong demand for the company's solutions from both new and existing customers.

There are two Hold ratings and one Buy (Macquarie) on the database. The consensus target is $5.36, suggesting 1.3% upside to the last share price.

See also, Technology One On Course For Profit Growth on October 5 2017.
 

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