Ride Computacenter's upgrade cycle

Computacenter provides IT infrastructure and services to corporate and public sector clients in the UK (39 per cent of sales), Germany (46 per cent), France (13 per cent) and Belgium (2 per cent). In 2017, revenue hit record levels, rising 17 per cent to £3.8bn, while margins are at historic highs. Moreover, the group has returned more than £300m to shareholders over the past five years, including a £100m tender offer in February 2018. 

The new highs being achieved by the business have been matched by the valuation of the company's shares, which, based on a multiple to forecast earnings, trade at around a 10-year high, according to Bloomberg data. But we think strong trading means this rating can be sustained while further forecast upgrades should underpin continued share price momentum.

The earnings upgrade trend is impressive (see graph), with forecasts for the current year and next financial year upgraded by 21 per cent and 25 per cent, respectively, over the last 12 months. Estimates look well supported. Brokers have already had to scramble to increase their EPS predictions twice this year: first when Computacenter reported full-year results in March highlighted an upcoming “year of progress” compared with market expectations of relatively flat trading; then in late April when the company revealed better-than-expected performance for the first quarter.

Importantly, we believe there is good reason to think the trend of positive surprises will continue. In the short term, there’s the impetus of the EU’s new data privacy rules (GDPR), which could play into the hands of re-sellers like Computacenter during second half as clients play catch up. In the longer term, customer demand is being propelled by a desire to digitalise businesses, to reduce the cost of running IT programmes by incorporating automation, and to move towards using private cloud infrastructure. Added to this is the need to migrate from the Windows 7 operating system to Windows 10 by early 2020, when support is scheduled to be withdrawn for the older software.

The strong trading conditions were reflected in first-quarter revenue growth of 23 per cent, or 21 per cent at constant currencies. This was flattered by a one-off software licence sale in the UK worth £34.1m, which was profitable but diluted margins. Still, excluding this deal, constant-currency sales rose 17 per cent. Computacenter operates through two business divisions – supply chain (about 70 per cent of sales) and services. Supply chain is currently the key source of growth; for the first quarter, excluding the non-recurring contract, sales here rose 25 per cent.

Trading aside, Computacenter's healthy balance sheet could also prove a cause for broker upgrades. Broker Berenberg predicts Computacenter could generate £300m in free cash flow by 2020, giving it the potential to launch a new £150m tender offer. The broker reckons the consequent reduction in shares in issue could boost EPS forecasts by around a tenth. And while the high level of profitability currently being achieved by the business means margins are forecast to remain flat, Benenberg also notes that should the current strong conditions lead to further margin progress, it would be "material to the bottom line".

Where are Computacenter’s potential weak spots? As a re-seller, barriers to entry are low, which means margins are vulnerable should competition ramp up. We also learnt in March that a major contract was coming up for renewal in 2018, which could cause a trading hiatus. And the overall services business faces top-line pressure, as customers seek lower-cost long-term support contracts. But, for now, supply chain’s growth is successfully offsetting this and profitability is being maintained.