2023-06-29 17:25:44 ET
Summary
- DXC Technology has made a number of operating model changes in the past fiscal year.
- Management believes these changes will position the company for future success.
- While the changes appear promising, until leadership can reignite revenue growth despite challenging macroeconomic conditions, I'm Neutral [Hold] on DXC.
A Quick Take On DXC Technology
DXC Technology ( DXC ) provides businesses with IT consulting services and related software development.
I previously wrote about DXC with a Hold outlook.
Management has made significant changes to its operating model and a number of other aspects over the past several quarters; now, the biggest business risks to the company’s outlook are the slowing macroeconomic conditions that its clients are facing, so it will be difficult to generate growth in the near term.
Until leadership can prove that it can generate meaningful revenue growth, I remain Neutral [Hold] on the stock.
DXC Overview
Ashburn, Virginia-based DXC Technology was founded in 1959 and operates in two business segments:
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Global Business Services - software engineering, analytics
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Global Infrastructure Services - transforms legacy systems to the cloud
The firm is headed by President, Chairman and CEO, Mike Salvino, who joined the firm in 2019 and was previously Managing Director at Carrick Capital Partners and Group Chief Executive at Accenture Operations.
DXC also provides business process outsourcing for selected industry verticals such as insurance.
DXC’s Market & Competition
According to a 2021 market research report by Grand View Research, the global market for software consulting (as a subset of the firm’s broader array of services) was estimated at $219 billion in 2020 and is forecast to reach $542 billion by 2028.
This represents a forecast CAGR of 12.0% from 2022 to 2028.
The main drivers for this expected growth are the continued transformation of business activity to the cloud, the growing use of digital touchpoints across all aspects of the enterprise and the need to outcompete on the basis of technology, wherever possible.
Also, the chart below shows the historical and projected future growth trajectory of the U.S. software consulting market from 2018 through 2028:
Major competitive or other industry participants include:
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Accenture
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Atos
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Capgemini
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CGI Group
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Clearfind
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Cognizant
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Deloitte Touche Tohmatsu Ltd.
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Ernst & Young
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IBM
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Oracle Corp.
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PricewaterhouseCoopers
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Rapport IT
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SAP SE
DXC’s Recent Financial Trends
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Total revenue by quarter has fallen in recent quarters; Operating income by quarter has also dropped materially.
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Gross profit margin by quarter has edged up recently; Selling, G&A expenses as a percentage of total revenue by quarter have normally been around 7%.
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Earnings per share (Diluted) have fluctuated greatly in the last several years:
(All data in the above charts is GAAP)
In the past 12 months, DXC’s stock price has fallen 14.64% vs. that of the SPDR S&P Software & Services ETF’s ( XSW ) rise of 16.12%, as the chart indicates below.
For the balance sheet, the firm ended the quarter with $1.86 billion in cash and equivalents and $3.9 billion in total debt, of which $285 million was categorized as the current portion due within 12 months.
Over the trailing twelve months, free cash flow was $1.15 billion, during which capital expenditures were $267 million. The company paid $108 million in stock-based compensation in the last four quarters, the highest trailing twelve-month figure in the past eleven quarters.
Valuation And Other Metrics For DXC Technology
Below is a table of relevant capitalization and valuation figures for the company.
Measure ((TTM)) | Amount |
Enterprise Value / Sales | 0.7 |
Enterprise Value / EBITDA | 16.8 |
Price / Sales | 0.4 |
Revenue Growth Rate | -11.3% |
Net Income Margin | -3.9% |
EBITDA % | 3.9% |
Net Debt To Annual EBITDA | 3.5 |
Market Capitalization | $5,500,000,000 |
Enterprise Value | $9,330,000,000 |
Operating Cash Flow | $1,420,000,000 |
Earnings Per Share (Fully Diluted) | -$2.58 |
(Source - Seeking Alpha)
The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.
DXC’s most recent Rule of 40 calculation was negative (7.4%) as of FQ4 2023’s results, so the firm is in need of substantial improvement in this regard, per the table below.
Rule of 40 Performance | FQ3 2023 | FQ4 2023 |
Revenue Growth % | -10.8% | -11.3% |
EBITDA % | 18.2% | 3.9% |
Total | 7.4% | -7.4% |
(Source - Seeking Alpha)
Commentary On DXC
In its last earnings call (Source - Seeking Alpha), covering FQ4 2023’s results, management highlighted its free cash flow generation and expectations for free cash flow expansion in the coming fiscal year.
The firm has also changed its operating model to ‘be led by our offering leaders [which] gives our organization clarity’ for its seven offering categories.
Leadership also noted that its GBS segment has grown consistently over the past two years, offsetting the decline in its GIS segment.
DXC is also focused on reducing costs and plans to shed certain of its data center assets, going to an ‘infrastructure-light’ approach and will reduce contractors or move them to become employees.
Total revenue for FQ4 2023 fell 10.4% YoY, while gross profit margin rose 2.5%.
The company's large earnings loss was due to a pension plan buyout and an annual mark-to-market write-down of its UK pension asset values.
Looking ahead, management guided full-year fiscal 2024 revenue to be flat at the midpoint of the range and non-GAAP diluted EPS of $3.93 at the midpoint.
The company's financial position is relatively strong, with ample liquidity, significant long-term debt but strong free cash flow.
The firm plans to repurchase another $1 billion in stock over the coming fiscal year.
DXC’s Rule of 40 performance has been sub-par and has worsened in the most recent quarter.
From management’s most recent earnings call, I prepared a chart showing the frequency of key terms mentioned (or not) in the call, as shown below.
I’m most interested in the frequency of potentially negative terms, so management or analyst questions cited ‘Uncertain’ three times, ‘Challeng[es][ing]’ three times, and ‘Macro’ three times.
The negative terms refer to the challenging project environment as clients have become more cautious and are deferring or canceling discretionary projects.
While DXC has made significant changes to its operating model and a number of other aspects, the primary business risk to the company’s outlook is the slowing macroeconomic conditions that its clients are facing, so it will be difficult to generate growth in the near term.
Until leadership can prove that it can generate meaningful revenue growth, I’m Neutral [Hold] on the stock.
For further details see:
DXC Technology Changes Operating Model As Growth Sags