Accenture: Consulting Growth Overcoming Outsourcing Weakness

After the market closed on December 20, 2006, Accenture (ACN) reported results that exceeded analysts' expectations. The next morning the price jumped up. For the first quarter of 2007, ending November 30, 2006, Accenture reported net revenues of $4.75 billion, an increase of 14 percent over the same period last year. GAAP diluted earnings per share were $0.46, an increase of 28 percent over the first quarter of fiscal 2006. New bookings were $5.5 billion, while consulting recorded $3 billion in consulting bookings. Operating margin expanded by 50 basis points to 12.8 percent. Utilization, a key measure of staff working on revenue producing engagements, was 86%, a very good number.

By the way, Accenture expects net revenues to be $4.6 billion to $4.8 billion for the 2nd quarter of 2007.

Key drivers

The key drivers for Accenture are bookings, utilization and rate per billable hour. Since bookings are higher than sales, they may be able to generate more billable hours which will drive revenue higher. However, utilization has remained above 80% for the last 15 quarters. With last quarter’s utilization at 86%, I expect there will be some decline in billable hours due to lower utilization. This will result in lower revenue in the 2nd quarter 2007, keeping in mind that the 2nd quarter includes the Christmas and New Year’s holidays.

New contract bookings for the three months ended November 30, 2006 were $5,479 million, a decrease of $62 million, or 1%, from the three months ended November 30, 2005, with consulting bookings increasing 6%, to $2,955 million, and outsourcing bookings decreasing 9%, to $2,524 million. The average size of their outsourcing contract new bookings has decreased when compared to outsourcing contract bookings for the three months ended November 30, 2005.

While their total bookings are higher than reported revenue, they were lower in the 1st quarter of 2007 compared to the 1st quarter of 2006. The lower bookings are entirely from lower outsourcing bookings. Consulting generally has rate per hour, resulting in higher operating margins, while outsourcing usually has lower hourly rates resulting in lower operating margins, especially in the first year of the contract. As the mix of services moves in favor of consulting, the margins will increase.

As long as bookings remain higher than sales Accenture should continue to grow. Many companies are embarking on re-development of their technology that supports their business. This trend should contribute to Accenture booking new business.

On the other hand, utilization will likely drop some as consulting services become a larger part of the total services delivered by Accenture. Remember, outsourcing contracts typically have higher utilization rates than consulting services.

In summary, bookings should continue to grow with higher margins, while utilization should fall slightly, staying above 80% for now.

Management

The management of Accenture are long term employees of the company with substantial experience in the consulting and outsourcing business. As a result they understand the consulting and outsourcing business very well. The only negative is there is likely to be minimal outside perspective that can be brought to the company. This has not been a problem for Accenture in the past.

Other considerations

In the latest quarter Accenture repurchased 24.4 million shares totaling $723.7 million. At November 30, 2006, the company had $1.4 billion of share repurchase authority remaining, or 4.3% of the total market cap of $32.67.

The Company was engaged by the National Health Service in England [NHS] to design, develop and deploy new patient administration, assessment and care systems for local healthcare providers and, subsequently, to provide ongoing operational services once these systems were deployed. On September 28, 2006, the Company entered into a tripartite agreement with the NHS and Computer Sciences Corporation (CSC), an unrelated third party, under which the Company agreed to transfer to CSC all of its rights and obligations under the NHS Contracts, except those relating to the Picture Archiving Communication System. The Company expects to substantially complete the transfer during the second quarter of fiscal 2007.

In connection with the transition and wind-down of Operational Services work related to the NHS Transfer Agreement, the Company expects losses not to exceed $125,000 in fiscal 2007. On October 4, 2006, the Company remitted approximately $50,000 in settlement of liabilities in connection with the NHS Transfer Agreement. In addition, during fiscal 2007 the Company will repay approximately $120,000 to the NHS, representing the difference between the deployment and services billings that the Company received under the NHS Contracts during their terms and the amounts the Company is entitled to retain by agreement under the NHS Transfer Agreement. This amount was recorded in other accrued liabilities in the Consolidated Balance Sheet as of November 30, 2006. The Company’s remaining obligations under the NHS Contracts are immaterial.

Accenture benefits from Pre-Tax Earnings Yield of 11.4% and Pre Tax return on Capital of 135%. These are nice numbers is you are a value investor.

Conclusions

Accenture should continue to experience positive growth in the low double digits. In the 2nd quarter. I expect a slight drop in revenue and EBIT due to lower utilization and the payment to NHS. After that growth and earnings should continue to grow at low double digits through 2007.

Disclosure: Author has no position in ACN.

Comments

[Greg Calder...:]

Cramer called this tonight as a good outsourcing/consultati... play. I watch his show and read his reviews at cramersez.com or thestreet.com. Both good sites.

2007 Jan 16 07:29 PM