DWS: Interim result 2015

Everything was going backwards in DWS's half-year result earlier this week, and the only saving grace is that this had been flagged first at the AGM in November and again in a December profit warning (see DWS flags first-half writedown on 17 Dec 14 (Buy – $0.97)).

With so much preparation, it's little surprise that the result came in at the top of the guidance range, but that shouldn't disguise the weakness of the performance.

Including the writeoff on the Borealis joint venture, earnings before interest, tax, depreciation and amortisation (EBITDA) was $7.46m, but it only came in at the top of the $7.0-7.5m range given in December because the writeoff – at $551,000 – was less than expected. Excluding the writeoff, EBITDA was $8.0m, towards the bottom of the range given at the AGM, of $7.75–8.5m, and down from $9.5m last year.

Leverage

Revenue was only 2% lower than the first half of 2014, but operating leverage from the fixed cost of 489 highly paid consultants on the company's payroll (unchanged from last year) took the fall to 16% at the net profit level (excluding the writeoff).

Management expects economic conditions to 'remain subdued for the remainder of FY15' and noted that 'utilisation in Jan and Feb was lower than anticipated due to delayed project starts', although March is apparently looking stronger.

One possible ray of sunshine is the company's new 'Cloud Manager' product, which is currently undergoing patent review but is expected to be released shortly. We'll refrain from being too cynical, because this kind of development is exactly what the company should be doing, but it won't be the only company out there with a cloud product.

There are also bright spots in the company's financials, most notably its excellent cash generation, with almost all profit appearing on the balance sheet as cash. In the latest half, capital expenditure came to a grand total of $153,000 out of operating cash flow of $5.4m. Around 90% of net profit is then paid out as dividends, with the rest building up on the balance sheet and being used for acquisitions or, recently, share buy backs: 445,000 shares have been purchased since 19 December, at an average price of $1.06.

PER up; price down

On the conference call, management confirmed that the the third quarter had been underwhelming and that the second half was unlikely to improve on the first (excluding the writeoff). On that basis, the company will do well to make more than 8.5 cents of earnings per share for 2015 (and quite likely less), compared to the 12 cents we were hoping for when we upgraded the stock in IT Services under a cloud on 16 May 14 (Buy – $1.12).

That means the price-earnings ratio (PER) has gone up while the share price has gone down, which is not how we like it to happen. The market has presumably allowed the PER to rise (from about 10 to 13) because it thinks the earnings are now that much more depressed, and therefore liable to bounce back. We're not so sure. For one thing the economy looks like getting worse before it gets better. Ironically, by depressing the yields on government bonds that may have increased the attractions of the stock's high dividend yield but, with a high payout ratio and volatile profits, this is not a dividend on which to hang your hat.

More importantly, after another year of weak earnings, it looks increasingly like the problems for DWS may be more permanent than temporary, either within the sector generally or the company specifically. On the latter point, there's a notable contrast with SMS Management & Technology, which today reported a 48% rise in half-year operating profit on a 15% increase in revenue, alongside an expanded contract pipeline. We'll be updating on SMS in due course, but it's evidently doing a better job of reinventing itself. Its better performance also vindicates our suggestion to hedge your bets between these two stocks.

There may also be some hope of a takeover, but that's always a lousy reason to hang onto a stock. There may be more value in DWS to a buyer than on its own, but with the structural changes in the market there's also an incentive to cherry pick the right staff. Any deal would also have to suit founder, chairman and 42% shareholder Danny Wallis.

So, with the stock down 3% since our original upgrade and up 12% since we updated on December's profit warning, we're going to cut and run. Our Sell price drops all the way from $1.60 to $1.00 and – all things being equal (which they almost certainly wouldn't be) – we'd be interested in having another look below 70 cents. SELL.

Disclosure: The author owns shares in DWS and plans to sell after members have had an opportunity to do so.