CGI Inc.: Investor Day Outlines The Path To A Narrowing Valuation Gap

Summary

• CGI Inc. outlines its latest three-year plan at its investor day.
• Digital remains the key growth driver, while IP development plans and M&A could also drive incremental upside ahead.
• With CGI trading well below closest peer Accenture, shares continue to offer plenty of upside potential.

John M Lund Photography Inc/DigitalVision via Getty Images

Following an upbeat investor day presentation, CGI Inc. (NYSE:GIB) appears set for a return back to its pre-COVID-19 growth trajectory (both organic and inorganic), with recent fiscal 2021 results also supporting the case for further outperformance post-pandemic. Yet, CGI’s operating prowess and focus on profitable growth seem undervalued in the current market environment, which seems to favor high-growth names. With plenty of upside potential to be unlocked from an accelerated M&A strategy as well, the current valuation gap to closest peer Accenture (ACN) should narrow over time.

IP30 Targets Headline the Three-Year Growth Plan

The key headline from the event was CGI’s three-year plan spanning growth from consulting, IP, and global delivery centers. While IP revenue continues to hover in the low-20% of the total top-line contribution following recent M&A, the fact that CGI reiterated its IP30 targets at the event was an encouraging sign. This time around, however, management has put a timeframe around it, targeting a 30% mix by fiscal 2025. The IP ramp-up will be achieved through the deployment of Retail Suite and several financials-focused offerings such as Trade 360, with the end-goal being to build out IP as a key part of the business and an important driver of client value over the medium to longer term.

Source: CGI Investor Day Presentation Slides

In addition, CGI will also look to leverage acquisitions and co-creation with clients to get to its IP30 target. Of these, service-based acquisitions were pegged as the most significant driver of expansion, highlighting that management is not looking to acquire pure IP. Instead, management commentary seems to indicate its openness to paying slightly higher valuations for IP assets, as long as there is a clear line of sight to unlocking revenue synergies and a solid ROI. On balance, I view the commitment to IP development as a positive and expect the expansion in IP to not only drive margins but also attach and renewal rates going forward.

Expanding Capacity to Capitalize on Digital Tailwinds

Notably, CGI is also targeting a 15-20% three-year CAGR for its consulting business, primarily on the back of growth in digital. The ongoing digital-led mix shift is significant - c. 60% of bookings in the last fiscal year were for digital projects, while 60+% of the current pipeline is made up of digital work (note this was the first time CGI had disclosed its digital bookings contribution). And CGI’s guidance calls for this trend to continue, with digital revenue growth hitting double-digit % in the upcoming years (comprising mainly high-end strategic consulting projects and end-to-end digital modernization work). Yet, even with the headcount growth to support this shift, CGI still expects its EBIT margins to range at c. 16% (in-line with the 16.4% EBIT margin in FQ4 ‘21). With its short and long-duration contracts also containing provisions to recover inflationary cost growth, I see plenty of support for CGI’s medium-term financial targets.

Source: CGI FQ4 ’21 Presentation Slides

Flexible Balance Sheet to Drive Accelerated Pace of Acquisitions

Another notable takeaway from the event was CGI’s commitment to accelerating the pace of acquisitions in fiscal 2022, even if it means stretching its valuation limits higher. Specifically, management has guided toward $800 million to $1.2 billion in M&A spend on the metro market and tuck-in acquisitions in the upcoming year, well above the sub-$100 million in fiscal 2021. Interestingly, CGI’s M&A strategy uses geography as the primary filter, with 16 primary countries and 200 metro markets - this makes sense as CGI’s staff can move between verticals within each geography as needed. IP is a crucial M&A focus as well, which should accelerate the 50% Y/Y acquired IP growth noted in the prior quarter as CGI extends its IP’s reach across its global client base.

Source: CGI Investor Day Presentation Slides

Thus far, CGI has started fiscal 2022 off strongly, with the acquisitions of Array, a leading digital services provider for the US Department of Defense, and Cognicase, a Spain-focused technology and management consulting services company. There remains plenty of room for M&A-led growth from here - CGI is equipped with c. $3.2 billion in available liquidity (comprising $1.7 billion cash and $1.5 billion debt) as well as a low leverage ratio of 0.7x. The latter should allow CGI to increase its leverage levels to pursue transformational acquisitions going forward – increasing leverage to the targeted 2.5x, for instance, would result in the unlocking of $4 billion in liquidity. And with CGI also planning to remain active on share repurchases (despite the stepped-up M&A), I see plenty of incremental upside ahead.

Final Take

Overall, the event made a strong case for the viability of CGI’s strategy to lean in harder on growth via organic (e.g., increasing headcount and adding more IP) and inorganic means. Assuming successful execution, I see this driving continued momentum in bookings through the upcoming year, as CGI capitalizes on the pent-up demand for digital transformation across its customer base. Yet, despite an improving business environment, CGI continues to trade below its pre-COVID-19 levels – this contrasts with Accenture, which has already seen its valuation multiple move well beyond pre-pandemic levels amid solid top and bottom-line trends. With operating margins in-line with ACN and revenue growth set to improve in the upcoming years, I see a clear opportunity for CGI’s multiple to expand going forward.

Data by YCharts

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

Comments

[teemacsj]

Thanks for highlighting in this article. I was just reviewing this last week. As much as I like ACN and own the shares, most would not realize that CGI has had better free cash flow per share growth over time and has done a better job at opportunistically buying in stock using FCF as opposed to ACN paying a regular, growing div and buying shares every year seemingly regardless of value. Either way, both firms will see their services in demand for years.