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Does Accenture's Business and Balance Sheet Compensate for Valuation?

Accenture PLC (NYSE:ACN) is a name that I have followed for some time, but have never owned. The stock gapped higher by almost 8% Thursday following earnings results. Is the stock a buy following earnings? Let's find out.

Company back ground and recent earnings results

Accenture is a professional services company that provides technology, consulting and outsourcing services. It provides solutions to a wide variety of businesses, including banks, media and communications, retail, travel and public services. Ninety-five of the company's 100 largest clients have been with Accenture for at least 10 years. The company has five business components: Products, Financial Services, Communications, Media & Technology, Health & Public Service and Resources. Accenture is headquartered in Dublin, Ireland and trades with a market capitalization of nearly $136 billion.

The company's revenue declined 1% to $11 billion for the third quarter of fiscal 2020 (fiscal year ends Aug. 31). Adjusting for currency exchange, revenue was 1.3% higher. This was $103 million more than what analysts who cover the stock had expected. Earnings per share declined 1.6% to $1.90 per share, though this was 6 cents above estimates.

Consulting revenue improved 4% to $6 billion even as revenue from reimbursable travel costs were down 3%. Outsourcing revenue grew 3% to $5 billion. Digital, cloud and security sales accounted for 70% of total revenue, a new record.

By region, U.S. sales moved higher by 2% to $5.2 billion due in large part to double-digit growth in public services, life sciences and software and platform. Banking and capital markets also performed well, while high-tech, chemicals and natural resources were weak spots.

Europe was down 2% to $3.6 billion. Gains made in software and platforms, but health and life sciences were offset by decreases in consumer goods, retail and travel, high-tech and banking capital markets. Italy and Germany were outperformers, but Accenture's business declined in the U.K., Spain and France.

Sales for the company's Growth Markets increased 5% to $2.2 billion. These regions had strength in chemicals and natural resources, public service and software and platforms. As with Europe, consumer goods, retail and travel were all down year over year. Japan led the way during the quarter.

Business segments were mixed. Communications, Media & Technology and Financial Services with revenue of $2.2 billion and $2.1 billion, respectively, were flat from the prior year. Products declined 1% to $3 billion, while Resources dropped 3% to $1.6 billion. Offsetting these declines was a 12% surge in Health & Public Service revenue.

For the first three quarters, all markets and business segments have shown growth from the previous year. The company has seen strength in North America, higher by 7%, and Growth Markets, up 10%, as well as Health & Public Services, higher by 13%, and Products, up 7%.

Net bookings increased 4% to $11 billion in the quarter. Bookings consisted of $6.2 billion for consulting and $4.8 billion for outsourcing. Gross margins improved 30 basis points to 32.1%, while expenses increased 20 basis points to 16.5% due to the Covid-19 pandemic. Accenture repurchased 3.5 million shares at an average price of $179 during the quarter, which is considerably below the current share price. Net bookings for fiscal 2002 have gone up 11% to $35.6 billion.

Accenture issued updated guidance for the remainder of fiscal 2020. The company expects revenue growth of 3.5% to 4.5% in constant currency, compared to 3% to 6% previously. Accenture raised the low end of its earnings per share guidance and now projects a range $7.57 to $7.70 for the full fiscal year.

Given the difficult environment due to the Covid-19 pandemic, Accenture performed quite well. Revenue and earnings results were lower from the prior year, but still came in ahead of estimates. Bookings for the quarter and year remained solid and every region and business is higher over the first nine months of the year. The company, unlike many, also provided guidance for the remainder of the year. Granted, there is one quarter to go in the fiscal year and thus higher visibility, but Accenture still raised the low end of its guidance. The new midpoint of $7.64 would be a 4.1% improvement from fiscal 2019.

The company has a pristine balance sheet with $6.4 billion in cash against total debt of just $3.4 billion as of the end of the last quarter. Accenture also generates significant free cash flow (see the next section).

Finally, Accenture has compounded its annual revenue by at a rate of 6.4% over the last decade while net profit increased 10.4% over the same period of time. Accenture has excelled at transforming sales into profits. This is reflected in the company's net profit margin growth, which was 7.7% in fiscal 2010 and 11.1% in fiscal 2019.

Dividend and valuation analysis

Prior to the Nov. 15, 2019 payment, Accenture had paid a semi-annual dividend. The company has since transitioned to a quarterly dividend. Following a 10% increase for the payment made last November, Accenture has increased its dividend for the past 15 years.

According to the U.S. Dividend Champions, Accenture has increased its dividend by an average of:

  • 9.0% per year over the past three years.
  • 8.9% per year over the past five years.
  • 14.8% per year over the past 10 years.

The most recent increase is above the short and medium-term average dividend increases. With an annualized dividend of $3.20, shares yield 1.5%. Using data discerned from Value Line, the current yield is below the 10-year average yield of 2.1%.

Accenture's yield might be on the low side, but the dividend appears well protected.

Using the annualized dividend and the midpoint of EPS guidance of $7.64, the earnings payout ratio is 42%. This isn't too far off the average payout ratio of 38% that Accenture has had since 2010.

Accenture paid out $509 million in dividends during the third quarter while producing free cash flow of $2.6 billion. This equals a payout ratio of less than 20%. For fiscal 2020, total dividends distributed comes to $1.5 billion and free cash flow was $4.6 billion for a payout ratio of 33%.

These free cash flow payout ratios are quite low, but are they outside of what Accenture usually produces?

From fiscal 2016 through fiscal 2018, Accenture paid out $4.7 billion in dividends to shareholders, while free cash flow totaled $13.9 billion. This equates to a free cash flow payout ratio of 34%. This is higher than the third quarter's ratio, but in line with the first three quarters of fiscal 2020.

Accenture's dividend looks extremely safe, which helps compensate for its low yield.

And now for valuation, which can be considered very rich.

Shares of Accenture trade for $213 as I write. The stock's trailing price-earnings ratio is 29 when using last year's earnings per share of $7.34. Using the midpoint of EPS guidance for 2020, the forward price-earnings ratio isn't much better at 27.9.

The five-year average price-earnings ratio is 21.1, while the 10-year average price-earnings ratio is 18.3. Shares of Accenture are quite expensive against either historical average.

I am willing to give a company a higher target valuation range if the business is performing well and the balance sheet is strong, which looks to be the case for Accenture. But even lifting my target valuation range to 22 to 24 times earnings per share would result in a deep dive in the share price. Using fiscal 2020 estimates and my target valuation range, I find that Accenture is worth $168 to $183. Trading within this range would result in a 14% to 21% decrease in the value of the stock.

Final thoughts

Accenture held up decently during the third quarter of its fiscal year, with solid bookings growth in a difficult environment. The company's balance sheet is one of the best that I have reviewed recently. The dividend appears to be very safe, but the stock's valuation has me hesitating to purchase at the moment. Accenture would be much more attractive at a lower price. For that reason, I will not be adding shares at this time, but the stock remains on my watchlist.

Disclosure: The author has no positions in any stocks mentioned in this article.

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This article first appeared on GuruFocus.