While Warren Buffett may be attracted to IBM, I believe Accenture (ACN) is the true value play in business services. Its free cash flow generation is significantly under-appreciated, despite strong momentum. In this article, I will run you through my DCF model on the company and triangulate the result against a review of the fundamentals compared to IBM and EMC Corporation (EMC).
First, let's begin with an assumption about the top-line. Accenture finished FY2011 with $27.4B in revenue, which represented an 18.4% gain off of the preceding year. I model 10.6% per annum growth over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold at 69% of revenue versus 18% for SG&A, and 1.3% for capex. Taxes are estimated at 28% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $77.90, implying just north of 33%. The market seems to be factoring in a WACC of 12.5%, which is much too bearish in light of the 0.8 beta and 2.3% dividend yield (which has recently been hiked). The stock trades reasonably at 12.4x FY2011 free cash flow.
All of this falls within the context of an excellent quarter:
New bookings were again strong, just shy of $8 billion. Revenue came in at the top end of the range we guided to last quarter, and EPS for Q2 were very strong.
Revenue growth was broad-based across our operating groups and geographic regions, with outsourcing growth higher than consulting for most of those dimensions. Our performance through the first half of the year and into calendar 2012 positions us well to achieve our targets for the full fiscal year.
From a multiples perspective, Accenture is also attractive. It trades at a respective 15.5x and 13.6x past and forward earnings versus 14.8x and 11.9x for IBM and 22x and 12.7x for EMC.
Consensus estimates forecast IBM's EPS growing by 12.2% to $15.08 in 2012 and then by 10.1% and 9.3% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $16.45, the stock would hit $213.85 for 8.1% upside. While IBM is not attractive from a reward standpoint, it is a stable business with a beta of 0.66. This perhaps explains why Warren Buffett may have invested a large portion of his holdings in the company. On the other hand, the dividend yield is fairly weak at 1.7%.
Consensus estimates forecast EMC's EPS growing by 15.2% to $1.74 in 2012 and then by 14.9% and 19% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $1.95, the stock would hit $31.20 for 22.4%. While the company does not offer a dividend yield, it is rated a "strong buy" on the Street (source: NASDAQ). Like EMC and Accenture, it is also less volatile than the broader market and thus is fairly safe against a double dip.
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