How Accenture's Distribution Of Strong Earnings Provides A Great Margin Of Safety

Sep. 3.14 | About: Accenture plc (ACN)

Summary

The world's leading consultancy firm has incredibly stable return on equity.

Deep industry ties and a big commitment to cloud services indicate that Accenture will continue to be an industry leader for some time.

The size of Accenture and the consistency of their operation gives us a reasonable chance to estimate future performance.

In this article, we will provide insights into how Accenture PLC's (NYSE:ACN) distribution of earnings between dividends, reinvestment and share repurchases make the consultancy a great buy at the current price. The analysis will be a case study of hypothetical scenarios to assess what future potential investors should expect.

Accenture is the world's largest consultancy as measured by revenue. It has extremely deep industry ties: Among its clients are 91 of the Fortune Global 100 companies and more than 75% of the Fortune Global 500 companies. With revenue of $31.13 billion and net income of $2.91 billion, this Fortune Global 500 consultancy is itself a giant both within its industry and on a global scale.

However, what we believe makes Accenture a tremendous investment opportunity is its strong earnings history coupled with a clever distribution of the earnings between reinvestment, dividend payouts, and share repurchase programs. Let's take a closer look at how this is done, and what it tells us about the future.

Hard Numbers

Over the last 10 years, Accenture has posted extremely high and consistent return-on-equity levels. Compared to consulting rivals IBM (NYSE:IBM) and Hewlett-Packard (NYSE:HPQ), Accenture provides both higher and more reliable (less volatile and more stable) return on equity, as is clear from the table below (data taken from MSN Money):

Year

Return-on-equity (%)

Accenture

HP

IBM

2004

61.0

9.3

29.3

2005

59.4

6.4

25.2

2006

54.2

16.5

30.8

2007

62.8

18.9

36.6

2008

73.5

21.5

58.8

2009

58.6

19.3

74.4

2010

62.2

21.6

64.9

2011

67.8

17.9

73.4

2012

63.6

-41.4

85.2

2013

72.1

20.6

79.1

Mean:

63.5

11.3

55.8

CoV:

0.095

1.8

0.40

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The CoV is the coefficient of variation (also known as the unitized risk), which is the ratio of the standard deviation over the mean. Intuitively, it is favorable to have as low a coefficient of variation as possible, as this points to both high return on equity and the possibility of more accurately predicting future results. Given such consistent return on equity, a realistic estimate for future earnings will be the total shareholder's equity multiplied by the historical mean return on equity.

How does the company spend its earnings? Accenture has an average dividend payout ratio of 26.4%. Moreover, the company spent an average of about 40% of earnings buying back its own shares in the market, and by the latest financial reports it seems that it will continue to aggressively buy back shares. This means that 33.7% of earnings are being added to the total shareholders' equity, through either reinvestment, increased cash holdings, or paying off debtors.

Possible Future Scenario for Accenture

With current total shareholders' equity of $5.6 billion, we expect (purely from our estimates above) that next year's net income will be $3.5 billion (63.5% of $5.6 billion). Provided Accenture chooses to continue its policy regarding the division of earnings, this will result in $1.4 billion worth of share repurchases, $0.93 billion in dividends paid, and an increase in the equity base of $1.19 billion through reinvestment. If we expect current P/E levels to persist, this simple iterative method enables us to calculate the number of outstanding shares and thereby EPS for any given number of years in the future. Given our own investment horizon and the increased uncertainty associated with estimates further into the future, we chose to look at a five-year period. Following this hypothetical scenario to the end, our method yields the following estimates for 2019:

Accenture 2019 estimates

Earnings:

$20.21 billion

EPS:

$35.66

Share price (current P/E):

$652.8

Shareholder's equity:

$15.85 billion

Total dividends:

$80.85 billion

Dividends per share:

$14.26

Outstanding shares:

566,780,000

Click to enlarge

This provides long-term investors with an annualized rate of return of 23.2%, excluding dividends (24.2% including dividends). It is noteworthy that we have computed the result using the current P/E ratio of approximately 18, which is low in historical terms. With a P/E closer to the historical mean, the annualized rate of return could be up to 30%, excluding dividends.

Accenture's Margin of Safety

Of course, as everybody knows, past performance isn't always a good predictor of the future. In Accenture's case, however, there are reasons to believe that current trends will continue. Accenture has succeeded spectacularly well in holding on to its clients: Of its 100 biggest clients, 99 have been customers for the last five years, and 91 for the last 10. This shows both a commitment to Accenture's business model and the company's focus on customer service, but it also shows that Accenture understands it needs to keep its services up to date.

This latter point is particularly evident when looking at the company's investment in cloud consulting. With the increased importance of cloud-based services, Accenture took on a role as a self-proclaimed broker of cloud services. This essentially meant that the company specialized in helping costumers implement cloud-based systems. The success of this line of business has made Accenture invest an additional $400 million in its cloud services, and so far it seems to have paid off with cloud-generated revenues having surpassed $1 billion annually.

To back these somewhat intangible arguments, Accenture boasts a very strong balance sheet. We believe this would provide an extremely solid safety net for Accenture in the case of a potential shock. More specifically, Accenture has enough cash (and equivalents) to pay back it long-term debt over 150 times. Moreover, it has low levels of operating activities, which together with the lack of debt indicates that the company's expansion is also financially viable.

Concluding

We find Accenture to be an investment opportunity of high quality. The company looks attractive whether one analyzes the company structure or the financials. With deep industry ties, it has shown that it is a company that is willing to both commit to existing customers and to keeping its services relevant. Also, with almost zero long-term debt, its expansion (both internally and externally) has been financed through reinvestment and nothing in our analysis indicates that this should change in the future. This analysis suggests -- based on incredibly consistent return on equity -- that the annualized rate of return on a five-year investment made at current prices (and constant P/E) could reach 24%.

Disclosure: The author is long ACN.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.