The Motley Fool

Is it time to party for these IT businesses?

It’s curious when a data driven world has little time for those whose business it is to make the use of data more effective. Yet that’s essentially what’s happening with the IT management / services sector of the economy which has remained in the doldrums since the GFC. However green shoots are starting to appear and these two companies are sure to benefit.

SMS Management & Technology Limited (ASX: SMX) operates through two divisions. MS Consulting offers a wide range of services including performance improvement, process management, customer relationship management, infrastructure management and an extensive range of managed services. Major clients include the finance industry, governments, utilities and resource companies. The other division is M & T Resources which handles recruitment needs and provides IT contractors.

SMS has high fixed costs (mostly staff), no debt, a healthy cash balance and is very leveraged (up & down) to the level of activity in its industry. Management misjudged the outlook in the 2014 first half and contractor utilisation fell to a record low of 81%. This had a severe effect on the bottom line with margins rapidly falling to 3.7% (normally 9.62%). Following this dismal result the cost base has been adjusted and the second half will be much improved. Pleasingly management noted that activity is finally picking up with NSW and Queensland leading the way. The large quantity of mooted infrastructure projects will help underwrite the performance of this leading IT services company for some years to come.

Selling at $3.73, SMS is on an estimated 2014 price earnings ratio of 18.75 and a fully franked yield of 4%. This year should see a low point in the IT industry business cycle and SMS is a value buy on the medium-term outlook.

Data#3 Limited (ASX: DTL) is fully focused on developing the “Hybrid IT” solution – on premises, outsourced and cloud services. Although first-half revenues were only down 1.8%, net profits collapsed by 62.3%, providing further evidence that the overall IT industry is cannibalising itself with extreme margin compression in order to ‘stay’ in business. This type of tactic is temporary by nature and typical of a cycle end.

Data#3 has reacted by rationalising the business and simplifying company focus. Five unwieldy divisions have been cut to three. With no material debt this company is well placed to survive and resume a growth path from 2015. At 60c Data#3 is selling at an undemanding indicative price earnings ratio of 15 (2014) and a fully franked yield of 5%.

Foolish takeaway

Both these companies are on pace with developments and are positioned to leverage profits considerably when the cycle turns – as it will. Both are at three-year lows. In a generally happy market investors can do well by looking at those sectors which remain uninvited to the party. Although SMS is my personal preference at this point I think both are significantly undervalued on medium prospects.

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Motley Fool contributor Peter Andersen owns shares in SMS Management & Technology

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