Accenture Deserves A Premium Valuation

Summary

• ACN beat Q1 2018 analysts' estimates and management raised the company's fiscal 2018 guidance.
• ACN shares are richly valued, but I believe that the company's stock deserves to trade at a premium.
• ACN shares are a long-term buy at today's price.

On December 21, 2017, Accenture (NYSE:ACN) reported better-than-expected Q1 2018 earnings and revenues. The company also raised its fiscal 2018 guidance and management now expects to achieve double-digit EPS growth (10-13%) for the current year. As you can expect, Accenture's beat and raise was well-received by the market.

Taking a step back, this company has reported impressive operating results over the last few quarters, so investors should not be surprised that ACN shares are outperforming the broader market by a wide margin so far in 2017.

Source: Nasdaq

ACN shares are up big in 2017 and the company's stock is trading at a relatively high valuation (more on this below), but, in my opinion, Accenture is still a long-term buy at today's price.

Recent Quarterly Results

Accenture reported Q1 2018 adjusted EPS of $1.79 on net revenues of $9.5B, which beat top- and bottom-line analysts' estimates. Moreover, the company's Q1 2018 adjusted EPS and net revenues were up 13% and 10%, respectively, from the same period of the prior year.

Source: Q1 2018 Earnings Presentation

As shown, 4 out of 5 of the company's operating units reported double-digit net revenue growth for the quarter and the 5th unit (i.e., Health & Public Service) had growth in the high single digits. I was really encouraged by the company’s broad-based revenue growth, in addition to the strong new bookings number ($10B), but I believe that the growth reported for the company’s digital, cloud, and security services businesses (i.e., "The New") was the major takeaway from the Q1 2018 earnings release.

The New now accounted for approximately 55% of the company’s total revenues and the growth has been tremendous since it was launched 4 years ago (net revenue up 3x). Plus, The New does not appear to be slowing down anytime soon, which means that these operations should continue to move the needle for this company through 2018 and beyond. This was actually a topic that management highlighted during the Q1 2018 conference call:

Our very strong results in the first quarter demonstrate that we continue to execute our strategy very well and are clearly benefited from the substantial investments we have made to build differentiated services and further enhance our competitiveness.

I am especially pleased with our continued rotation to the new digital, cloud and security, which again grew at a very strong double-digit rate this quarter. We have been particularly successful with Accenture Digital, nearly tripling the annual revenue from this business since we launched it four years ago. And we have expanded our capabilities to help our clients with their digital transformations.

Now, given the increasing importance of artificial intelligence, automation, machine learning and other innovative technologies, we are evolving Accenture Digital to be even more relevant to our clients and drive even greater differentiation in the marketplace.

- Pierre Nanterme, CEO

The company has three main pillars of growth in the digital space - Accenture Interactive, Accenture Industry X.0, and Accenture Applied Intelligence (all discussed in great detail in the conference call that is linked above) - that will be key growth drivers in the years ahead and, in my opinion, the company’s differentiated digital capabilities will create a lot of shareholder value over the next 12-18 months.

It is important to note that Accenture is not a one-trick pony either, as shown by the fact that the company's largest operating unit by revenue, Products, recorded its 10th consecutive quarter of double-digit revenue growth.

Source: Q1 2018 Supporting Materials

More importantly, looking forward, management believes that Accenture is in a position to benefit from improving market conditions. To this point, management raised the company’s fiscal 2018 guidance:

For fiscal 2018, the company now expects net revenue growth to be in the range of 6 percent to 8 percent in local currency, compared with 5 percent to 8 percent previously.

The company now expects GAAP diluted EPS to be in the range of $6.48 to $6.66, compared with $6.36 to $6.60 previously. The updated EPS range represents 19 percent to 22 percent growth over GAAP EPS of $5.44 for fiscal 2017, and 10 percent to 13 percent growth over adjusted EPS of $5.91.

Accenture continues to expect operating margin for the full fiscal year to be in the range of 14.9 percent to 15.1 percent, an expansion of 10 to 30 basis points from adjusted operating margin for fiscal 2017.

For fiscal 2018, the company continues to expect operating cash flow to be in the range of $5.0 billion to $5.3 billion; property and equipment additions to be $600 million; and free cash flow to be in the range of $4.4 billion to $4.7 billion.

Accenture's fundamentals are strong and its business prospects will likely to improve over the next 3 quarters. Long-term shareholders will be happy to hear that management also expects to return at least $4.3B through dividend and share buybacks, with intentions of retiring ~1% of total shares outstanding in 2018.

Valuation

Accenture's stock is trading at a premium when compared to its peer group.

ACN PE Ratio (Forward) data by YCharts

But let's remember that Accenture is in growth mode while IBM (IBM) and HP's (HPQ) - peers per Morningstar - growth has slowed over the last three years.

ACN Revenue (3 Year Growth) data by YCharts

Accenture's strong net revenue growth is one of the main reasons why I believe that the premium valuation is warranted, and it is encouraging that the Street is on the same page.

Word From The Street

Analysts are currently bullish on Accenture with 7 "Strong Buys" and an average price target of $156 per share.

Source: Yahoo! Finance

Additionally, Cantor Fitzgerald recently raised their price target for Accenture to $180 per share (from $151 per share) and maintain the Overweight rating for the company.

At 23x forward earnings, Accenture is what I would consider richly priced, but this company deserves a premium valuation. Moreover, I believe that the company will grow into its current valuation in short order as current estimates will likely be increased in the quarters ahead.

Risks

As described throughout this article, Accenture is highly levered to the digital space so any major disruption to The New would significantly impact the company's business prospects.

Additionally, reputation risk is an importation consideration because Accenture is the go-to consultant in its industry. Specifically, ACN shares are trading at a premium to its peers (and the market), so a negative shift in investor sentiment would materially impact the company's stock price.

Bottom Line

Accenture's stock is richly valued, but, in my opinion, this company deserves to trade at a premium. My biggest takeaway from the company's Q1 2018 results (and management commentary) was that management appears to have Accenture well-positioned for the future, especially in the digital consulting space. In addition, as described in this article, market conditions for Accenture continue to improve and this should bode well for the company (and its shareholders) over the next five plus years.

As such, investors with a time horizon longer than two-to-three years should consider any significant pullbacks as buying opportunities.

Author's Note: Accenture is a core holding in the R.I.P. portfolio, and I have no plans to reduce my stake in the near future.

Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.

Disclosure: I am/we are long ACN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.