Transformation imperative accentuated
PSI's (HN:PSI) FY14 sales and earnings fell short of expectations as the economic and geopolitical turmoil held up progress in a number of areas, although cash flow performance was meaningfully ahead. We pare back our FY15 and FY16 estimates to reflect PSI’s ongoing geopolitical and economic risks. This further setback highlights the importance of management’s drive to transform the business, through consolidating products onto a single platform and moving from a services-led to a product-led software revenue model. Our analysis suggests that, while some margin improvement beyond our forecasts is priced in, successful execution should unlock value significantly north of €15.
Geopolitical risks bite
Full-year sales of €175.4m (Edison €176.2m) were down slightly year-on-year, but lower than anticipated Q4 licensing orders in BRIC countries and Thailand resulted in reported operating profit coming in at €7.2m, below our €8.7m forecast. Cash performance was significantly better than anticipated, with lower capex and a working capital inflow (vs an outflow modelled) helping year-end net cash expand to €24m vs our forecast of €1.5m and up from €14.9m last year. Management’s full-year guidance of mid-single-digit growth and €11m EBIT probably errs on the side of caution, but drives a 23% cut to our FY15 EPS estimate.
Importance of transformation programme highlighted
This setback highlights the importance of the company’s ongoing transformation programme to add resilience to the model and put the business back on a margin-expansion trajectory. A shift towards a more product-led vs project-based model should reduce exposure to cost overruns and free up working capital. The progressive migration of customers and products onto a unified technology platform should improve development, product maintenance and efficiency implementation.
Valuation: Good upside potential from a turnaround
Following the downgrades, PSI’s rating is trading at even more acute recovery multiples, with a low EV/sales (1.2x) but an uncompelling P/E (24x), based on our FY15 EBIT margin estimate of 6%. However, while there will be challenges along the way, with good execution on the transformation plan, we believe that EBIT margins can be expanded to the mid-teens level within four to six years. Our DCF analysis shows that, in most circumstances, expansion of operating margins to 12% should justify a share price of higher than €15, while achieving 15% would justify a share price closer to €20.
To Read the Entire Report Please Click on the pdf File Below