Accenture: 4Q isn’t expected to yield much of a recovery

Morningstar’s equity analyst Julie Bhusal Sharma shares her view on stock post its latest quarterly results.
By Morningstar Analysts |  03-08-20 | 
 

Accenture reported healthy 3rd-quarter results with revenue and earnings per share.

Discretionary revenue was hit the hardest, with Accenture’s consulting arm experiencing weakness compared with its outsourcing arm, which handles more mission-critical business operations.

Nonetheless, the company benefited from lower costs in the quarter due to pandemic-related items, such as less unbilled travel costs.

In the 4th quarter, we now expect more moderate signs of recovery, as management lowered its full-year revenue guidance while narrowing its EPS outlook. On the other hand, we are more optimistic concerning 2021 operating margins, as we expect more pandemic-related cost benefits to bleed into the next fiscal year.

Accenture’s fiscal third quarter was strong given the circumstances, with reported revenue of $11 billion, marking a 1% year-over-year decrease in U.S. dollars. Lack of reimbursable travel revenue was responsible for bringing total revenue down 200 basis points in what would have otherwise been a 1% year-over-year increase.

The IT consultant attributed the mild revenue decline to the diversity of its clients’ industry verticals, citing 50% of revenue coming from less impacted verticals like Life Sciences and Public Service. Accenture’s cloud and security businesses were strong in the quarter, while areas like intelligent platform saw significant pressure after previously experiencing double-digit growth. Despite the weakness, we were comforted that Accenture did not report project cancelations above typical levels. Rather, client budget constraints manifested themselves in increased postponed projects.

  • Fair Value Estimate, or FVE
  • Fair Value Uncertainty: Medium

We are maintaining our FVE of $187 per share for Accenture. With the stock up 7% after earnings, we’d look for a greater margin of safety before investing.

We think that Accenture is subject to medium fair value uncertainty given the risks native to the IT services and consulting industry.

Like most consulting businesses, Accenture is sensitive to utilization of its employee base. The company has maintained utilization rates in the low-90s over the last five years. However, the increasing use of automation in Accenture’s processes may result in lower utilization rates if Accenture can’t best predict its personnel needs.

Attrition is another risk that comes with a consulting and outsourcing business. The company has experienced greater attrition over the last two years. Accenture has noted that this increase has not carried over into their more skilled talent in consulting and strategy. However, a crossover into consulting or strategy attrition could cause the value of Accenture’s intangible assets to suffer. Accenture has also suffered increasing denials of H-1B visas, though this has affected the entire industry. Additionally, while Accenture is in the top 30 H-1B employers in the U.S., the company’s H-1B employees make up less than 15% of its employee base.

A key risk of being in the business of vague deliverables is underdelivering from the client’s perspective. For example, in April 2019, Hertz filed a $32 million lawsuit against Accenture for not delivering on the goals set out in Accenture’s revamp of the Hertz website. While the lawsuit was small compared with Accenture’s overall cash flows, such news could negatively impact Accenture’s reputation and consequent deal flow.

While Accenture has stressed its desire to rely less on commoditized outsourcing, we think that this could pose risks to Accenture’s familiarity proposition, which is that switching costs are derived from having such large client accounts. Accenture has high service reviews on its more mundane outsourcing services, which we believe to work in favor of Accenture when clients decide on consultants.

  • Economic Moat: Wide
  • Moat Trend: Stable

Accenture is one of the largest IT services company in the world, providing both consulting and outsourcing capabilities. We think that Accenture’s growth will remain at a healthy and gradual pace, rather than experience a massive uptick.

With Accenture’s prominent reputation, which we believe to be crucial to the consulting business, and its proven ability to bring expertise to a gamut of enterprise issues, we are confident Accenture will maintain its wide moat business.

The wide moat rating stems from intangible assets, largely derived from Accenture’s reputation and expertise. Accenture also benefits from switching costs, as we think familiarity makes it hard to risk changing consultant or IT outsourcing providers. We think intangible assets are apparent through Accenture’s consulting projects, which make up 56% of Accenture’s top line. This includes traditional consulting services spanning areas like supply chain, blockchain, talent, and overall digital transformation, but it also covers higher level strategy consulting for areas like tech, mergers and acquisitions, and security.

Accenture has a strong reputation around reliability but also a treasure trove of institutionalized industry expertise and experience. Not only does Accenture have technological and strategic proficiency across a wide variety of industries (which smaller consulting shops might be able to replicate in niche markets or industries), but just as important, Accenture has the expertise to handle large scale enterprise contracts with diamond accounts that smaller competitors simply can’t match. As a result, we think Accenture’s place as the 28th best brand worldwide (according to BrandZ) is evidence of its reputation, which we consider an extremely valuable intangible asset to Accenture that enables it to gain larger client accounts that are looking for extra insurance in the high-cost world of enterprise projects.

  • Stewardship: Exemplary

The company has a track record of delivering on its promise to shareholder returns with discipline.

The firm also carefully ensures that organic growth is the majority of its revenue story, with inorganic growth typically composing only 2% of revenue. While there is speculation that Accenture’s recent acquisition blitz of marketing firms makes it just a holding company, we believe Accenture will be able to integrate these new agencies in a way such that they can leverage Accenture’s core competencies.

Furthermore, we have confidence that Accenture’s relatively new CEO, Julie Sweet, will be able to maintain Accenture’s strong business and effective stewardship of capital.

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