Innovation Group: Full-Year Results

Innovation Group performed robustly in 2012, delivering its second year of strong earnings growth with good cash conversion. BPO trends look positive while investment in the software suite creates a platform for high margin software growth. A lower tax charge prompts a 13% EPS upgrade, with scope for further upside.

Robust Performance, Particularly In H2 Against Headwinds
Sales grew 3% organically to £194m vs. our £199m forecast, suppressed by adverse currency movements (growth was 8% constant currency), but PBT was slightly ahead of our (£18.1m) forecast at £18.4m, up 22% y-o-y. Profitability improved markedly in H2, with adjusted EBIT expanding 32% y-o-y (64% sequentially) to £10.8m despite bearing the brunt of adverse currency movements. A lower tax charge helped adjusted EPS come in ahead at 1.3p vs. our 1.0p forecast, while year-end net cash at £26m was £1m ahead of our estimate.

Looking Well Placed For 2013 And Beyond
Trends look positive for the BPO operations, where sales grew 12% y-o-y to £171m. Gross margins remained steady at 39%, but recovered from 37% in H1 to 40% in H2, driven by restructuring in Germany and the UK, the increasing contribution from higher-margin property services and healthy trading, particularly in South Africa, North America and Asia Pacific. Software sales were flat at £22.5m with licensing growth (£3.8m vs £3.4m last year) suppressed by the slippage of a £1m licence deal, into this year (now signed). There are reasons to expect robust growth going forward: all major software products have now been re-architected, the launch of smaller ticket (but shorter sales cycle) products such as analytics, rapid access and gateway should add to the mix, as should OEM deals, such as the recently announced Analytics partnership with insurance software provider Xuber (part of Xchanging Group). With good execution, a significant inflection in software sales (and therefore margins) is possible this year.

Estimates: Tax-Related EPS Upgrade, Scope For More
Operational forecasts have not changed materially, but a lower tax charge (25% from 29%) brings adjusted EPS up 14%.These estimates look very achievable, with software deal flow and BPO contract wins in the US providing potential avenues for upgrades.

Valuation: Margin Expansion Should Deliver Upside
The upgrade to EPS reduces Innovation’s 2013 P/E to 16x from the high teens rating it has maintained over the past year or so. This is a slight premium to comparable UK software or global BPO companies, but not unwarranted given the cash backing (ex-cash P/E is 14.1x) and scope for upside. Strong software and BPO deal flow is the key catalyst for upside through pricing in more significant earnings expansion.

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