Friday, March 29, 2019

Accenture's IT Services Impresses Once Again During 2019

Accenture (ACN) impressed with strong 9% c/c revenue growth, record bookings and further increase in FY2019 (August year-end) revenue growth guidance. Growth was skewed towards resources and communications verticals while financial services and heath & public services verticals underperformed. Read-through for other IT names—demand environment is reasonable even as there are rough edges visible in weak financial services growth.

ACN—strong headline numbers with growth skew towards a couple of verticals

Accenture reported a strong 2QFY19 (quarter ending February 2019) with c/c revenue growth of 9%, at the upper-end of 6-9% guidance band. Organic c/c revenue growth stood at around 7.5%. Growth was led by communications, products and resources growing at 12%, 10% and 22% in c/c. On expected lines, financial services was weak and grew at 2% in c/c. Health & public service grew at muted 3% caused by decline in Federal Government revenues in the US. New services (digital, cloud and security services) contributed more than 60% to revenues in 2QFY19 and grew in double digits. Strategy & consulting services and technology services grew in high single digits.

Operating margin increased by 20 bps yoy. Three of the five operating segments reported yoy decline in EBIT margin with a big swing in numbers resulting from sharp increase in profitability of the resources vertical. Bookings were at record level of US$11.8 bn, recording a new high and grew 15.1% yoy. Consulting bookings grew 18.6% and outsourcing bookings grew 10.9%. We note that new bookings number for the quarter includes reimbursement of expenses, something which was not included in the previous year numbers.

Revenue growth guidance raised to 6.5-8.5% from 6-8% earlier

The company raised FY2019 revenue growth guidance to 6.5-8.5% from 6-8% in the previous quarter and 5-8% at the beginning of the year. Accenture has also guided for 5.5-8.5% revenue growth for 3QFY19. The company expects 1.5% contribution to revenues from acquisitions. The company intends to spend US$1.5 bn on acquisitions in FY2019, of which it has already closed 15 acquisitions entailing outflow of US$515 mn in 1HFY19. Operating margin expansion guidance of 10-30 bps for FY2019E remains unchanged. ACN indicated that macro risks remain with potential for an economic slowdown. However, volatility is the new norm with clients continuing to invest in technology to drive revenue growth and create operational efficiencies.

Financial services—weak banking, especially in Europe, strong insurance

On expected lines, financial services practice was weak for ACN. The insurance segment grew in double digits. However, the company reported moderate decline in revenues in banking and capital markets contributed by decline in Europe. Growth in North America banking was also muted. The company indicated strong bookings in all segments of financial services and expects growth to rebound in the second half of the year.

We believe that IT spending will be muted in the capital markets segments, especially in Europe. We expect steady spending in the traditional banking segment in North America though there may be spending caution from a couple of large clients. Spending outlook at a broader level will be slower than 2018. Growth for individual player will be a function of exposure to sub-segments of the banking vertical and share gains/losses in consolidation decisions.

Read-through for other companies

ACN management indicated potential of a slower economic growth. Client budgets may grow at slightly slower pace compared to 2018. However, this slower growth has not translated in weak growth outlook. ACN's revenue growth for FY2019 will be similar to FY2018.

For offshore pureplays, growth will be a function of two factors—(1) slowdown in economic growth. Select segments in financial services and sub segments in manufacturing segment and hi-tech are displaying signs of weakness and (2) tailwind from increasing digital deal sizes and accelerated deal momentum courtesy clarity on simplification of the core. Admittedly a strong exit to FY2019, a bulging order book and positive commentary on demand should translate into a far better FY2020. However, the downside of a slowing market cannot be ignored either. All said, we expect FY2020E growth to be broadly in line with FY2019 growth. We expect acceleration in growth for a few companies and modest deceleration for others.

Is digital discretionary? ACN’s nuanced perspective does not seem to suggest so

ACN believes that despite the pace of disruption in global business, there is recognition that companies cannot pause digital spending. However, in the eventual situation of a slowdown, companies may push harder for operational efficiency and cost-rationalization agenda to fund digital spending. In a way the nuanced stance indicates a secular shift towards digital spending with adjustment in spending by doubling down on efficiency expectations from vendors in case of a slowdown.

Key highlights from earnings call

New bookings. New bookings were broad-based and in line with strategic offerings. 65% of the new bookings were for digital, cloud and security offerings.

Growth momentum in the new to continue. Accenture expects strong growth momentum in the new to continue despite the businesses having reached significant scale. The company believes that most companies are in the early phase of adoption of digital technologies. Leverage of growth from digital technologies is a multi-year play.

Accenture Interactive. Accenture has done seven acquisitions in FY2019 to enhance scale and differentiation in key markets. Accenture is the world’s largest provider of digital marketing services.

Applied Intelligence. The practice combines advanced analytics and artificial intelligence, with Accenture’s domain and business expertise. Accenture has 20,000 people focused on Applied Intelligence, including 6,000 deep and artificial intelligence in data science.

Industry X.0. The practice uses digital technologies to help clients transform their core operations. Accenture has about 10,000 people in Industry X.0.

Accenture Security. Accenture is one of the leading providers in security market. The practice is growing in double-digits and is expected to have an annual revenue run-rate above US$2 bn in FY2019.

Cloud. Accenture is a leading integrator for cloud partners such as Microsoft Assure, Amazon Web Services and Google Cloud platform. The company is well-positioned to tap growth opportunities from demand for custom cloud applications.

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