Under the Radar: ASG Group

PORTFOLIO POINT: Shares in the Perth-based IT services group have more than doubled in the past year, and offer a solid yield.

Australia’s IT industry is small; the sector accounts for just 0.8% of the S&P/ASX 300 Accumulation Index. But that is no reason to ignore it given that some of Australia’s top performing companies – such as Computershare – have come from the sector.

In addition, these companies have the types of earnings structures that make them very easy to analyse from a financial standpoint and, as a whole, the industry has proven to be quite resilient in the face of broader economic challenges.

The Perth-based IT services group, ASG Group Limited (ASZ), has been a particular standout. The company describes itself as a provider of “technology applications and business systems integration to government agencies and private companies nationally”.

What you might not be able to glean from that description is that as a company that operates in Australia’s fastest growing state, it’s a direct beneficiary of government stimulus and bureaucratic largesse.

The company’s clients include BHP Billiton (BHP), Rio Tinto (RIO) and Barrick Gold, the NSW Parliament, the WA Department of Planning and Infrastructure, Melbourne University, AAPT, QBE Insurance (QBE), Ericsson, ANZ Banking Group (ANZ) and BMW.

After looking at this company’s underlying business model, you come away with the impression that it is essentially the IT back office of an enormous blue-chip conglomerate, with a few government branches thrown in for good measure.

From a top-down perspective, ASZ can be viewed as both a defensive and a growth stock. It is defensive in the sense that dividends have been paid every six months since 2004, it has strong financial health and predictable cash flows.

It is growing in the sense that every year it adds new contracts to its books and market capitalisation has risen from $12.7 million in mid 2000 to about $217 million today.

More importantly, growth is forecast to continue. The company is expected to pay a 4.5¢ fully franked dividend following its forthcoming full-year earnings result, which provides a solid yield on a stock that closed on July 7, 2010, at $1.43. Meanwhile, earnings-per-share (EPS) growth for the year is forecast to be almost 6%.

Such growth isn’t necessarily high for ASG historically speaking, but forecast 2011 EPS growth is 31.11% from expected 2010 levels. Further, continued contract wins suggest we could see a surprise on the higher side of forecast earnings and we also believe that ASZ’s present work-in-hand hasn’t yet been factored into the company’s share price.

Lincoln thus currently holds a valuation of $1.69 on the stock, which represents upside of approximately 18% from current levels.

That’s not to say ASG has been lacklustre in the charts to date. Despite showing a somewhat volatile pattern, the company’s stock is up over 102%, including dividends, from this time last year. And, over a five-year period, ASZ has delivered a 31.44% average per annum return, also including dividends.

Although a small-cap, and one that is generally under-researched, ASZ has unsurprisingly attracted the attention of a variety of canny fund managers including Paradice Investment Management, Renaissance Asset Managers, Australian Foundation Investments and Souls Funds Management.

ASZ is also pleasingly liquid, with average daily volumes of about $290,000.

Compared with other companies in the sector, ASZ appears expensive in terms of current and forward price/earnings (P/E) multiples, and P/E over growth (PEG) ratios, but justifying these are ASZ’s excellent cash flows.

In the IT services industry – where payment terms can be 90 days or more – cash is king.

Compared to the industry average, ASZ has produced consistently strong operating cash flows, whether measured against total tangible assets or measured as a ratio of cash balance changes to current liabilities.

Being an IT company, ASZ doesn’t have a huge amount of tangible assets (plant and equipment) but it does have zero bank debt and finished calendar 2009 with $10.3 million cash in the bank.

Even compared with some of the stronger companies in the IT sector, ASZ has very little operating risk. And, for a company of its size, it has a wide and growing client base and contract pipeline. Its latest contract win, announced on June 25, was a five-year corporate IT support deal with Vodafone Hutchison Australia. ASG has secured $140 million worth of contracts for the first half of 2010 and has a pipeline of qualified contract opportunities for 2010-11 of $784 million.

ASZ’s growth has also been achieved through strategic acquisitions of its own, the latest being an EPS-accretive acquisition of Capitotech, which has strengthened ASZ’s relationship with blue-chip corporate and public sector clients.

Other recent acquisitions include Dowling Consulting, based in Victoria, and Courtland Business Solutions, which operates in the lucrative SAP market.

With offices in five states and the ACT, ASZ has more in common with many of its east coast peers than many other West Australian small-caps. And unlike those businesses, ASZ is one Perth-based stock that’s positively exposed to both big mining and big government, a rare thing indeed.

The bottom line is that all organisations have evolving IT needs, no matter what industry they inhabit and what platforms they use. ASZ is dynamic operator within a well-performing and economically resilient sector and we believe its progress to date speaks for itself.

Michael Feller is an equities analyst at Lincoln Indicators, which developed Stock Doctor, a premium sharemarket research solution.