After EOH (JSE:EOH) had a superb run in 2013 in which its shares soared 112%, the majority of analysts dropped it from their stock pick lists for 2014 citing that it has become too expensive. This, however, didn’t deter investors who went on to push the counter a further 35% last year.
Despite a seemingly demanding price:earnings ratio now at 28, we believe this information technology company still has the ammo to justify buying in.
We think earnings growth of 25%-30% is still within reach. With annual revenue now over R7 billion, the company will have to add about R3 billion or more to maintain its previous growth rates of 40% or above. This will be difficult to achieve without the help of acquisitions.
However, if you take into account organic growth which in the past five years averaged 17% and add to that about R500 million of additional revenue likely to come from new businesses that were acquired in the course of last year but not fully incorporated, our conservative estimates can be easily surpassed. As new businesses bed down margins are also likely to tick up.
We have not factored in further possible acquisitions as yet. Given that it was sitting on over R1 billion cash war chest at the end of July, new acquisitions can’t be ruled out even though we didn’t include them in our estimates. Given its record of value-adding acquisitions, this is probably a source of additional upside. Intellidex’s discounted cash-flow model shows the company is still in the buy region with upside potential of 18%.
Our confidence is based on the fact that its recent growth has been delivered from an even mix of acquisitions and existing businesses. Its aggressive acquisition strategy in the past four years absorbed more than R1.8 billion and has undoubtedly been the main driving force behind its strong results. After having relied so much on acquisitions their role is slowly diminishing. This allays the risk of a sudden drop in earnings.
And the role of organic growth is already significant.
The latest results for the year to end-July show that existing business contributed close to half of the 32% growth in headline earnings.
Revenue jumped 42% to R7.2 billion with more than half being organic.
Its winning formula for acquisitions has been carefully structured. It is implemented in small packages which has mitigated risks that are often associated with big acquisitions. Most of the acquired targets also fit perfectly into the overall group structure, delivering immediate enhancements to group earnings. They have also brought in new skills and geographic and sector diversification, creating a strong foundation for future organic growth.
It has built an excellent reputation among large SA companies, its main client base. Now with the added advantage of size, we don’t envisage anything preventing above-average growth.
Huge potential for growth has also been opened up through expansion into other African markets where it now operates in 29 countries. CEO Asher Bohbot (pictured) says expansion into the rest of the continent has the potential to contribute about a quarter to group revenue in the medium term. This sounds like a conservative target given the potential but it is likely to face fierce competition from local and international players who are also targeting African markets. The company has adopted a strategy of following its SA clients into the rest of Africa which gives it an edge over its international counterparts.
After a series of acquisitions, intangible assets and goodwill have risen to R2 billion or more than a third of total assets. This lowers the quality of the balance sheet, but barring any surprises will be amortised gradually.
Overall, EOH presents a solid investment case whose business is built on a low-risk, service-based model with good annuity income characteristics. This, coupled with a management team that is superb at cherry picking value-adding acquisitions, identifying emerging trends in the IT space and has excellent capital allocation abilities, makes EOH a good fit for investors looking for a steady growth counter to add to their portfolios.
An added advantage is that is its operations also seem to be unhinged from global shock waves – it maintained earnings growth through the 2008/09 financial crisis. This is augmented by its high cash-generating abilities and a solid balance sheet with zero net interest-bearing debt. It also offers a decent return of 18% to ordinary shareholders (RoE) and a good dividend for those who will need a bit of cash.
Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view. For Intellidex’s full disclaimer, please click here.
Analyst: Orin Tambo; Editor: Stuart Theobald, CFA