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Data#3 Limited’s shares sink: Here’s what you need to know

IT consulting and services company Data#3 Limited (ASX: DTL) has disappointed the market with its full year net profit crashing 38%, compared to the previous year.

Data#3’s shares were down 8.5% at 75.5 cents in mid-morning trading.

Despite revenues rising 8% to $833.6 million, Data#3 saw net profit after tax fall as margins were pressured, thanks to higher staff and operating expenses. Net profit came in at $7.5 million compared to $12.1 million in the 2013. Net profit margin dropped from 1.6% in 2013 to 0.9% this financial year.

Looking at Data#3’s segments, product revenue (hardware and software) increased by 9%, but margins were hammered from 10% in 2013 to 8.9% in the 2014 financial year. Services revenue increased by 3.5%, but margins fells from 44.8% to 42.2%.

Data#3’s main issue is that it’s struggling to lower its cost ratio (gross profit/expenses), without damaging its business and customer relationships. And that’s the problem with a business with high fixed costs and low margins.

It’s an issue facing many IT consulting and service companies, such as SMS Management & Technology Limited (ASX: SMX), UXC Limited (ASX: UXC) and ASG Group Limited (ASX: ASZ). Their trailing 12 month profit margins are 4%, 3.1% and -11.7% respectively, according to Capital IQ data.

Luckily for Data#3, the company had a decent cash balance at the end of June 2014 of $103.4 million, with virtually no debt. With a market cap of $127 million, the market is virtually valuing Data#3’s business at $24 million. That appears cheap for a company that delivered a $7.5 million profit.

Unfortunately, the next financial year doesn’t appear likely to be much better, with Data#3 stating that it aims to ‘improve on the 2014 result‘. That doesn’t sound like a statement with much confidence.


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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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