Is ASG Group Limited a buy on strong results and outlook?

Earlier today, IT services company ASG Group Limited (ASX: ASZ) released a strong set of results for 2016. Revenue increased 16% to $188.7 million and earnings before interest, tax, depreciation and amortisation (EBITDA) rose 32.2% to $26.7 million. Net profit after tax (NPAT) was $12 million, up from $9.5 million in 2015 and earnings-per-share rose 27.5% to 5.9 cents.

Operating cash flows were strong and in line with EBITDA at $27.5 million which has enabled the company to pay down debt and buy back $5.1 million of shares during the year. Net debt was $2.9 million at 30 June 2016, down from $11.4 million a year earlier.

ASG signed contracts worth $300 million during 2016 and the company says its order pipeline is the strongest in its history. $185 million of revenue is already contracted for 2017, representing 98% of 2016 revenue, and the company is forecasting double-digit revenue growth in 2017 and 2018. It is also aiming to reinstate dividends in 2017.

IT services is following in the footsteps of the rest of the IT industry in transitioning towards a “pay as you go” revenue model. Previously it was expensive and disruptive to upgrade largescale IT systems and so clients of ASG would only do so periodically, usually when business conditions were favourable. However, new technologies such as Cloud computing have reduced costs and provide greater service and payment flexibility so IT spending is increasingly treated like any other fixed overhead.

Therefore, IT services companies should now enjoy much smoother revenue and earnings profiles compared to the past when they struggled with high fixed employee costs and lumpy revenues. Indeed, ASG’s EBITDA margins increased from 12.4% to 14.2% in 2016 exceeding the company’s target of 14% on the back of increasing revenue contribution from multi-year contracts.

IT Services companies are also benefiting from the continued expansion of the software industry in general. ASG’s core markets of Managed Services, Enterprise ERP and Business Analytics are predicted to grow to $38 billion in Australia by 2020 and the company currently has a market share of less than 1%.

I estimate that ASG is trading on a price-to-earnings ratio (PER) of under 18 based on today’s results which looks reasonable given the company’s strong outlook.

Another company which is benefiting from favourable trends in the IT sector is Citadel Group Ltd (ASX: CGL). It delivered EBITDA margins of 26.9% in the first half of 2016 and has made a couple of large, but very cheap acquisitions in recent years. Not only does it have higher margins and a superior growth profile to ASG, but it is also trading on a PER of just 13 based on my estimate of underlying earnings.

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Motley Fool contributor Matt Brazier owns shares of Citadel Group Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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