Softcat expects to profit from AI demand

The IT services businesses are in the gap between pandemic-driven investment and the expected arrival of artificial intelligence (AI).

Softcat (SCT) benefited from the enforced work-from-home shift during the pandemic. Companies needed to update both their hardware and software to accommodate this change. In the year to July 2022, gross invoiced income rose 29 per cent, driven by a 43 per cent increase in hardware income.

However, most hardware doesn’t need to be updated annually, and this year growth has slowed. In the six months to January, gross invoiced income rose just 4 per cent. Softcat did benefit from a better sales mix, with high-margin software growing 11.9 per cent, while hardware shrank 17.6 per cent. Consequently, operating profit for the group increased by 5.8 per cent.

Softcat has said that “interest from customers around Gen-AI is resulting in a lot of very positive customer engagement”. Meanwhile, it also said the “challenging conditions” during the second half of last year haven’t got any worse. If this is all true, then growth should improve in the coming year.

Management is forecasting that it will be able to maintain its double-digit gross profit growth forecast for the full year, while it expects operating profit to grow in the high single digits. Broker Peel Hunt pointed out that key hardware vendors such as Dell, Lenovo and Cisco have indicated they expect AI-driven demand to kick in during 2025. Correspondingly, Peel Hunt expects adjusted earnings per share to rise to 66.2p in 2026, giving a 2026 price/earnings ratio of 23.

This is expensive for a low-margin service company, but digitisation is inevitable, and someone needs to install it. Above all, there aren’t many companies in the UK maintaining double-digit gross profit growth. We stick to buy.

Last IC View: Buy, 1,198p, 24 Oct 2023