SMS Management: Result 2015

Back in May we confessed that our original investment case for SMS Management & Technology hadn't worked out, that the IT Services sector was not one we were 'keen to be in over the long term', and that (with some trepidation) we were hoping for a higher price to make an exit.

So it's with great interest that we note today's full-year results, which include a 48% rise in underlying earnings per share and have sent the share price up 9% to $4.08 – ahead of our $4 Sell price.

As ever with these things, there are some teasers to try to keep us interested. Most of all, the staff utilisation rate jumped from 80% to 84% in the core SMS Consulting division, due to a 14% rise in revenue and a slight fall in head count. That sent divisional earnings before interest, tax, depreciation and amortisation up 32% to $40m and was the main driver of group earnings growth.

The big gains were in financial services, where revenue grew 22% to contribute 27% of the total and telecoms, where revenue grew 40% to 25% of the total. 'Commercial' work fell 12%, while resources and infrastructure fell 9%.

Cash improvement

Cash generation also saw a marked improvement from the weak performances we noted at the 2015 half-year and 2014 full-year results, with work in progress falling 25% to $25.6m due to the unwinding of delayed milestone payments.

Overall, working capital fell 16% in the second half and rose only 6% over the year despite the increase in activity. This, combined with the revenue increase saw free cash flow more than triple over the year to $23.6m, well ahead of the $17.0m reported net profit. As a result, net cash stayed flat at $7.5m, despite $10m in dividends being paid and another $1m being spent on buying back shares.

So there are certainly signs that SMS's shift towards managed services work is having a positive effect and management expects the contribution from this type of work to increase again in the current year. Otherwise management was tight-lipped about the outlook, only offering that it continues to 'see signs of growth in what remains a competitive environment'.

By selling now we might miss out on some of this growth, but we're going to pay heed to our own words, that this is not a sector we're keen to be in over the long term, mainly due to the shift from high-value root-and-branch consulting projects to more competitive and lower margin cloud-based managed services.

The stock is up 26% since Is SMS Management a value trap from 4 May 15 (Hold – $3.24) and the same amount since our original Buy recommendation in IT Services under a cloud on 16 May 14 (Buy – $3.25). Adding in dividends of 14.5 cents gives a total return of 30% and we're content with that. SELL.