London’s software sector has not been short of takeover interest — see the proposed buyout of Aveva and recent delisting of Avast. FTSE 250 constituent Computacenter supplies rather than creates the technology but it also has all the hallmarks of a takeover target.
The Hertfordshire-based group’s shares trade at a substantial discount to its own long-running average and international peers, the business is debt-free, highly cash-generative and has already made good inroads into the vast US corporate IT services market. Those attributes and a weak pound could make the group alluring for a larger international rival.
A 36 per cent fall in the shares this year marks the reversal of a stellar re-rating since the March 2020 stock market crash. An enterprise value of 5.6 times forecast adjusted earnings before tax and other charges puts the group at its lowest valuation in at least nine years.
Why the markdown? A return to more typical rates of top-line growth after the boom in IT spending by companies during the pandemic as they readied their staff for home working. There is also naturally the concern that companies might tighten their IT budgets.
That profit growth this year and the next will likely be modest at best is hardly a revelation. Adjusted pre-tax profits rose by almost three-quarters over last year and 2020 and revenue was 33 per cent higher. The absence of corporate expenses such as travel during the pandemic provided one boost to the bottom line. The return of those costs represented a £20 million drag on profits over the first half, reckon analysts at Jefferies, a period when pre-tax profits declined 6 per cent. Without said costs, profit growth this year would be on track for a rate of 10 per cent, the brokerage thinks.
A look at Computacenter’s longer-term record is instructive — last year was its 17th year of profit growth. More rapid growth in IT spending has spurred compound annual growth of 12 per cent and 19 per cent in revenue and adjusted earnings per share, respectively, in the five years to 2020. The group focuses on selling services to large companies and government organisations, rather than SMEs or consumers.
Computacenter is highly cash generative and some of that cash has gone on acquisitions, $360 million spent in the US over the past three years on bolt-on deals to break into new parts of the country. Yet returns to shareholders are also on the table if the group’s coffers are ample enough — at the end of June, the group had net cash of £194 million.
There are risks that will spring to investors’ minds. One, that the barriers to entry in reselling software are low; two, that competition could slow revenue growth and erode pricing power and margins. Providing technology with services gives it a competitive advantage, according to Mike Norris, its boss.
Elevated inventory levels, which were £145 million higher than usual at the end of June at almost £400 million, might make some investors uneasy. The group has had to hold stock for orders that it cannot deliver without a critical part that might be in short supply, but customers are also ordering much further in advance of their needs. In almost all cases, there is a guaranteed sale on the items held in its warehouses, which removes much of the risk that it will be forced to offload stock at a discount. The inventory position should improve by the end of the year, management reckons.
The shares have still risen almost threefold in value over the past decade, outstripping gains made by the FTSE 250 over the same period. Takeover potential provides allure, but Computacenter has the potential to deliver longer-term compound gains as a standalone business.
ADVICE Buy
WHY Takeover potential and steady revenue growth could lead to strong compound returns for shareholders
PRS Reit
The jump in mortgage rates has pushed home ownership even further out of reach for many. PRS Reit is capitalising on demand for rental properties, contracting with big housebuilders such as Vistry and Countryside Partnerships, which are set to merge, to build homes on their mixed tenure sites.
The company is hoping to increase its portfolio from 4,856 homes at the end of September to 5,000 at the end of this year and 5,600 by the end of next year.
Crucially, PRS Reit reckons it has the liquidity available to reach that 5,600-home target without needing to secure additional financing. Just under two-thirds of the company’s debt is fixed at an average rate of 2.9 per cent, although its variable rate £150 million credit facility matures in February next year.
Analysts at Panmure Gordon expect to reduce their earnings forecast for next year, which currently stands at 4.2p a share, to reflect higher financing costs. Earnings should still cover the 4p-a-share minimum dividend payment being targeted for next year, the brokerage reckons. Based on the current price, that leaves the shares offering a potential yield of 4.7 per cent. However, growing beyond that level could prove more of a challenge as the cost of debt rises and PRS Reit is loath to raise fresh capital by issuing new shares priced at a discount to net asset value. That discount currently stands at 24 per cent against the NAV recorded at the end of June.
What does that reflect? Higher financing costs aside, fears that the cost of living crisis will cause an increase in arrears and limit growth in rents. On both counts, the performance thus far is encouraging. Arrears at the end of September stood at just £0.6 million, which would equate to just 1.7 per cent of the net rental income over the most recent financial year. Affordability has improved, with the average rent bill equated to 25 per cent of the average income for tenants across the portfolio, down from 29 per cent the prior year. Rents at renewal are being agreed 5 per cent higher than previous rates and 10 per cent for re-lets. The longer-term investment case for PRS Reit still stands.
ADVICE Hold
WHY Rising demand for rental properties could generate steady income growth
