Accenture (ACN) - Update - Earnings

Accenture announced earnings this morning and exceeded market expectations for both top line revenue and bottom line net income.  And the results would have been even better had it not been for foreign currency headwinds.  The main driver of Accenture's continued growth is a surge in digital services revenue and cloud services business.

Also encouraging, Accenture announced they are increasing their dividend by 8% and adding $5 billion to its share repurchase program.  Both of these are good things because it is a return of cash to shareholders.  Even though Accenture is growing quickly it still generates more cash than it needs, and is able to return a lot of it to shareholders.

Accenture's stock price has declined slightly this morning mainly because the overall market is down slightly.  However, the company also gave guidance for next year's earnings in a range of $5.09 to $5.24 per share, slightly below street expectations of $5.22 per share.

Bottom line, this is a great business, that generates lots of cash and continues to grow.  You can check out our complete thesis on Accenture here.

Accenture (ACN) Update

Since topping earnings estimates and raising guidance back on June 25th, ACN's stock price has steadily increased over 5% while the market (S&P500) has been basically flat.  We appreciate the gains, and maintain our "BUY" rating with a price target of $116.40 per share (current price is $104.83).  To review our complete ACN thesis and ratings report, click here.

Accenture (ACN) - Thesis

Rating: BUY

Current Price: $99.48

Price Target: $116.40

We own Accenture stock because we believe the market continues to underestimate the company's ability to deliver results.  We expect the stock price to consistently outperform the market in the future because of Accenture's workforce, culture, business model, balance sheet, pipeline, relationships, brand name, management and valuation. 

WHAT DOES ACCENTURE DO?

Accenture is a management consulting, technology services and outsourcing company with over 300,000 employees and offices and operations in more than 200 cities in 56 countries.  Accenture does NOT produce any products, but rather provides business and consulting services to help clients improve business performance.  The types of services Accenture provides to its clients are difficult for many investors to understand (which is part of the reason we believe the company is undervalued).  Here are a few examples of the types of services Accenture provides: Accenture helped:

HarperCollins Publish Their Entire Catalogue of about 36,000 Books on a New Digital Platform. More from Accenture.

Shell Implement a New Logistics Strategy, Improving Service Levels and Lowering Costs Up to 25%.  More from Accenture.

The London Police Force Fight Gang Crime with Analytics. More from Accenture.

Gas Natural Fenosa Transforms Their HR Practice, Improving Employee Satisfaction by 26 Percent in One Year. More from Accenture.

AN IDEAL BUSINESS MODEL:

We love Accenture’s business model.  It is ideal because its workforce has the ability to change dramatically, quickly and smoothly to meet demand.  Much of the global workforce is still stuck on this idea that a company hires a person, that person works for 40 years, gets a gold watch, and then retires.  That model is not efficient or even realistic for much of today’s world.  Accenture is hired by companies for a specific time period (often several months at a time, to several years at a time) to complete a specific project or task, and that’s it.  It’s often unrealistic for companies to hire full time employees just to complete a specific project because the company has no need for them when the project is complete.  Accenture solves this problem because when a project for one company is complete, Accenture sends its people to work on a project for another company (many Accenture people travel domestically and internationally on a regular basis).  It’s this adaptable, mobile workforce that enables Accenture to meet the needs of its clients, and it is an ideal business model for today’s rapidly changing business environment.

ACCENTURE’S VALUE PROPOSITION:

Accenture brings high quality people with specialized skills to complete specific client projects, and then the Accenture team gets out.  It prevents the client from hiring full time employees and then laying them off, and it allows the client to benefit from the very specific skill sets and experiences that Accenture people bring.  Accenture is not cheap, but client companies regularly find Accenture’s services worthwhile from a dollars and cents perspective.  Management is willing to pay for Accenture because of the improvements and successes they are able to achieve with the help of Accenture.

EXCEPTIONAL PEOPLE AND CULTURE:

Accenture’s greatest asset is its people.  The company’s diverse and inclusive workforce combined with its opportunities for upward career advancement enables Accenture to attract some very bright people.  The typical Accenture employee is in their twenties or early thirties, enjoys living in one of the large cities where Accenture offices are typically located, and is willing (even excited) to travel domestically or internationally to client sites.  Obviously, not all employees fit this typical description (some are older, and many positions don’t require travel) but many of them do, and it fits well within the workforce.  There tends to be a pyramid shaped workforce where younger workers make up the majority of the bottom of the pyramid, and there are a lower number of employees as you move up the ranks.  This works well for Accenture because as many employees get older and want to settle down with families they depart Accenture for less demanding jobs.  This natural attrition helps Accenture manage its workforce when demand is low because natural attrition is generally easier and cheaper than layoffs.  And when demand increases, Accenture’s culture and business model enable it to quickly attract additional high caliber, hard-working, determined people.  The high quality workforce model also enables Accenture to perform at a higher level than many other companies, which is part of the reason we believe the company is such a great investment.

BRAND NAME:

Having a strong brand name is one of the most valuable assets in business because it allows you to attract employees and customers, and it allows you to charge a premium for your services.  Accenture is not usually a recognizable name to the average person walking down the street, but within the ranks of corporate America, Accenture is a very strong brand name.  A long history of delivering exceptional performance to clients is the number one reason Accenture’s brand name is strong (the Accenture brand name has been around since 2001, but the company existed long before that).  There are other important contributors to Accenture’s strong brand name such as the diverse and inclusive workforce which often receives praise from the media.  For example, Accenture was named one of the 100 best companies to work for in 2015.

According to its website, Accenture takes: “the widest possible view of inclusion and diversity, going beyond gender, race, religion, ethnicity, abilities, sexual orientation and gender identity and expression to create an environment that welcomes all forms of differences. Every employee is a respected member of our team; we value individual similarities and differences, recognizing them as the thousands of diverse pieces—or tiles—that contribute to our entire mosaic.”

According to Chief Executive Officer, Pierre Nanterme, Accenture: “gives clients access to a rich range of talent, representing different styles, perspectives and experiences. This diversity is a critical strength that we work hard to maintain and foster. It makes us a better company on every dimension.”

ACCENTURE’S FINANCIAL STRENGTH:

A quick look at Accenture’s balance sheet reveals it has almost zero long-term debt.  This demonstrates the company hasn’t required debt to grow its business recently, but they do have the ability to take on debt in the future if need be.  Since the company does not produce actual products (it’s a service company) there is no need for large capital expenditures to enable growth (other than an occasional office upgrade – Accenture had only $322 million of capital expenditures in fiscal 2014 on an enormous $3.2 billion in free cash flow).  It’s nice to know the company is not burdened with massive amounts of debt.  Accenture also has $4.9 billion of cash on hand to meet liquidity needs.  The strong balance sheet and cash flow also allows Accenture to comfortably maintain its 2% dividend and repurchase shares as management stewards capital.

FUTURE GROWTH:

Accenture’s estimated earnings growth rate over the next five years is 10.13% according to 28 professional analysts covering the stock.  This exceeds the 7.28% those analysts are forecasting for the S&P which suggest they believe Accenture will grow faster than average.  We tend to agree Accenture will grow faster than the market, but we also believe it will grow faster than these analysts’ estimates.  Wall street consistently underestimates the value of this company because they do not have a strong enough appreciation for Accenture’s business model, it’s exceptional workforce & culture, and it’s powerful brand name within corporate America.  We also believe Accenture’s business is difficult for many people to understand, which causes them to avoid and under appreciate the stock. 

Near-term growth is expected to be generated across Accenture’s business groups, however Accenture Digital is the “hot” area right now.  According to Accenture’s 2014 annual report, the company recently launched Accenture Digital by combining their capabilities in digital marketing, analytics and mobility.  With more than 28,000 professionals, Accenture Digital is the world’s largest end-to-end digital capability and works with many industry leaders—including all of the top 10 global pharmaceutical companies as well as all of the top 10 consumer products companies.  In our view, there is a new “big thing” at Accenture with every market cycle (this time it seems to be digital).  However, it’s Accenture’s dynamic and adaptable workforce that enables it to profit from the market’s needs across market cycles.

VALUATION:

Ben Graham Formula:

We use a modified version of the valuation formula published in the 1930’s by Benjamin Graham (Warren Buffett’s mentor) to value Accenture at $116.55 per share.  Using Graham’s original formula (assuming a 5% growth rate), Accenture is worth only $101.97 per share [share price = EPS x (8.5 + 2 x growth) + cash per share = 5.18 x (8.5 + 2 x 5) + 4.9/0.79758.  However, we bump the growth rate up to 7% ($116.55 = 5.18 x (8.5 + 2 x 7) + 4.9/0.79758) because the company’s strong free cash flow will allow it to consistently strengthen EPS growth incrementally (as needed) with share repurchases, and we believe management is incentivized to do this as their compensation is tied to the stock price.

Discounted Cash Flow (DCF) Model:

Using a discounted cash flow model, we value Accenture at $116.25 per share.  Our model assumes Accenture can grow its 2014 free cash flow of $3.2 billion by 5% for the next five years and then 3% into perpetuity.  We assume a CAPM-derived required rate of return of around 8.3% and a long-term equity market return assumption of 7.5%.  We used a discount rate of 3%, and factored in the $4.9 billion of cash on hand.

RISKS:

The number one largest risk to Accenture’s business is anything that could hurt its brand name.  Because it doesn’t actually produce products (it’s a services company), a lawsuit or bad publicity could destroy the company’s ability to attract new business.  Accenture knows this lesson very well because of its history. Accenture was formerly part of Arthur Andersen, an accounting firm that was completely destroyed a little over a decade ago when the fraudulent actions of a few partners destroyed the company’s reputation and forced it to lay off thousands of employees and go completely out of business.  Accenture separated from Arthur Andersen several years before the scandal.  Accenture was known as Andersen Consulting when it first separated and then brilliantly changed its name to Accenture before the Arthur Andersen scandal allowing it to avoid unnecessary fallout from Arthur Andersen.  As another example of Accenture’s extreme aversion to bad publicity look to the Tiger Woods example.  Tiger Woods was paid huge sums of money to be the face of Accenture’s advertising and marketing initiatives, until a few years ago when news of Tiger’s indiscretions hit the news.  Tiger’s face had been pasted all over Accenture’s website and advertisements around the world, but within hours of the news Accenture’s leadership decided to drop Tiger Woods and remove his image from everything as quickly as possible.  This is a perfect example of how committed Accenture’s leadership is to protecting its pristine brand name, and of the lengths it will go to defend it.  Accenture leadership gets it.

CONCLUSION:

Accenture is a well-run, highly-profitable business, with a workforce well-suited for a rapidly evolving marketplace.  Its stock price is also inexpensive relative to its value.  We believe the market continues to underappreciate Accenture’s ability to deliver and its overall value.  We own shares of Accenture stock.