Something interesting is happening in the information technology (IT) services sector.
Established players like UXC Limited (ASX: UXC) and SMS Management & Technology Limited (ASX: SMX) have been losing out to lesser known names like Empired Ltd (ASX: EPD) and PS&C Ltd (ASX: PSZ).
Shares in EPD and PS&C have rallied well over 20% since the start of the year, when SMS is down close to 10% and UXC is barely at breakeven.
Where there are signs that corporate and government spending on IT projects is on the mend, it's still far from boom times for IT consultants.
But there is one niche area that is enjoying a robust outlook. This is in the area of network security where companies hire consultants to try to hack into their systems to expose vulnerabilities.
These hackers are called "white hats" as opposed to those with malicious intentions, who are called "black hats".
The chief executive of PS&C Kevin McLaine told me during a meeting yesterday that there is "too much work" in this area (the "S" in PS&C refers to "security").
No prizes for guessing which hat PS&C wears and the way the CEO was going on about this business unit indicates that "hacking", or penetration testing, could become the next growth driver for the IT industry after cloud computing.
Given the number of cyber-attacks corporate Australia and the government agencies have to endure and the new privacy regulation that will impose big penalties on companies that lose customer data, it is easy to see why McLaine is getting excited.
PS&C is well placed to capitalise on the expected growth of penetration testing as it is one of the more established players in the small but growing market.
On the flipside, it's a fragmented market with low barriers to entry. You can be sure competition will heat up.
What's more, it's difficult to find suitable "white hats" to recruit and that could mean smaller margins as salaries increase with demand for such services.
PS&C doesn't have any real competitive advantage, except for maybe its industry reputation. In fact, this neatly describes its other business units as well, which are SAP consulting and the installation of communication equipment.
I am not saying reputation isn't an important competitive advantage, but one has to wonder if that is enough to keep ahead in a fiercely competitive marketplace.
The good news is PS&C is one of the more attractively price stocks in the sector. While I am a fan of Empired (and I own the stock), it is looking closer to fair value than PS&C, which is trading on a 2014-15 forecast price-earnings of 7.4x, or a 33% discount to its peers.
Some discount is justified given its size and limited liquidity in the stock, but 33% looks a little extreme. I think a 10% to 15% discount is more appropriate.
This gives the stock around a 26% upside to fair value and I don't think it is a stretch to see it trade between $1.15 and $1.20 over the next few months, especially given that analysts are forecasting the stock to yield over 9% this financial year if franking credits are included.
The yield looks sustainable to me although a capital raising can't be ruled out as McLaine is not hiding the fact that he is keen on making acquisitions to expand the Melbourne-centric business to Sydney, if not beyond.
McLaine is wearing his growth hat.
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