A Strong Stock For Your Portfolio

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I have been long attracted to Accenture (NYSE: ACN)  as an industry leading, best-of-breed professional services company. I remember the old Tiger Woods advertisement that spelled out Accenture´s three key services: Consulting, Outsourcing and Technology at the end of the commercial. I like that Accenture built itself as a global leader in outsourcing services and IT consulting solutions. Accenture is a global leader in providing comprehensive consulting and technology services to a wide range of clients globally. In my view, the company is well positioned, because of its geographic scope, deep industry, and business process expertise considering it has 17 focused industry groups. Accenture is truly global, and its presence includes more than 200 offices in 53 countries, which allows them to effortlessly-serve clients around the world. These aspects give the company a competitive advantage over its competition since very few companies can match Accenture's scope of services. Its position on top is attributed to its corporate culture, which is focused on relationship building, customer-driven innovation, and adaptability to an ever-changing market. The company provides clients a broad and deep range of services and knowledge that ends up being relied upon. This leads to long-term relationships, because clients become familiar with the consultants and the implemented solutions become deeply instilled in clients' organizations. Client relations can never be compromised in the services industry, and Accenture is confident from the fact that 91 of its top 100 clients in 2010 have been with the company for more than 10 years.

Accenture is the true leader in the outsourcing consulting space

The company penetrated outsourcing early and established contact centers in low-cost destinations like India and the Philippines taking advantage of cheap labor. Entry into outsourcing generated Accenture a highly predictable revenue stream as most of the outsourcing projects are recurring, long-term contracts that do not follow clients' discretionary budgets. Presence in offshore regions lets Accenture effectively compete with other offshore-based IT service providers and gather significant market share in the rapidly growing offshore IT services industry.

H-P and Dell , since these companies joined into the IT software and services sector by blockbuster acquisitions and these companies have had mixed results from the services business. In the recent quarter, Accenture generated 6% revenue growth in US Dollar terms  and 9% in currency equivalent terms. A lot stronger than the 5% growth from Xerox ACS in 7% currency adjusted. Accenture and Xerox ACS outperformed Dell with 1% revenue growth in USD and HP Services at -1.27%.

I consider the best measure of a company’s capacity in creating value for shareholders is determined by comparing its return on invested capital (ROIC) with its weighted average cost of capital (WACC). The gap or difference between ROIC and WACC is called the company’s economic profit spread. Accenture's three-year historical return on invested capital, not including goodwill, is at 134.3%, which is more than the estimate of its cost of capital of 10.8%. In the chart below, I show how strong are Accenture´s execution metrics.

<img src="/media/images/user_13232/chart_large.png" />

Accenture has been generating economic value for shareholders for the past years. I expect the firm's return on invested capital, not including goodwill, to expand to 151.2% from 140.7% during the next two years.

Strong cash flow and dividend are reasons to invest

Accenture not only generates strong cash flow, it also pays a nice and growing dividend. The company’s annualized dividend has increased from $.30 during FY2006 to $1.35 by FY 2012. In addition, since its 2001 IPO, Accenture has been a buyback winner. The company was able to bought back almost $14B in shares during this period from the $20.3B in gross share repurchases and $6.5B in stock issuance for employee compensation programs. Accenture reduced its outstanding shares by 27% from 2004 to 2012.

Peer comparison

Compared to its peers, Accenture appears cheaper than outsourcing peers Infosys (NYSE: INFY) and Wipro (NYSE: WIT) on a P/S multiple basis. In fact, Accenture trades at 1.63x sales, cheaper than Infosys 3.91x sales and Wipro 2.52x sales. In addition, Wipro trades at 20x earnings and Infosys at 16x, very close multiples to Accenture´s 18.5x earnings. I feel much confident investing in Accenture. I feel that Accenture deserves to trade at a premium compared to these two Indian outsourcing businesses.

<img src="/media/images/user_13232/acn_large.png" />

Accenture has a remarkable combination of strong free cash flow generation and low financial leverage. I am expecting the company’s free cash flow margin to average about 11% in the next years. Total debt to EBITDA was zero last year, while debt-to-book capitalization stood at 0.1%. Since Accenture is a professional services business, which relies on strong manpower intelligence as its resource, is not a capital-intensive business requiring huge reinvestments of its cash flows in order to maintain its operations.

Last earnings proved that business is generating record bookings

Accenture's business model generates high returns on equity which have averaged an outstanding 62% over the last five years. This is even more impressive given that the company had no long-term debt and more than $5 billion in cash on the 8/31/11 year-end balance sheet. Accenture reported strong first quarter fiscal 2012 results as revenues increased 17% to $7.1 billion with EPS up 19% to $.96. This represented the company's highest quarterly revenue ever with double-digit local-currency growth in all five operating groups and all three geographic regions. New bookings for the quarter were $7.8 billion, with consulting bookings of $4.2 billion and outsourcing bookings of $3.6 billion. New bookings for the full fiscal 2012 year are targeted in the range of $28-$31 billion. Net revenue growth is expected in the range of 7%-10% for fiscal 2012 with EPS expected in the range of $3.76-$3.84, representing double-digit growth as operating margins expand.

My conclusion

My estimated fair value of $60 per share represents a price-to-earnings (P/E) ratio of about 19.2 times last year's earnings and an implied EV/EBITDA multiple of about 9.5 times last year's EBITDA. My model reflects a compound annual revenue growth rate of 5.6% during the next five years, a pace that is higher than the firm's three-year historical compound annual growth rate of 2.6%. Long-term investors should evaluate Accenture, a high quality firm with a durable brand, strong free cash flows and high returns on equity




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