Kainos: This 'rare' growth stock deserves premium rating

Both the company and its share price have grown rapidly since floating three years ago, but they're still undervalued, writes Graeme Evans.

Success stories as long lasting as Kainos Group are hard to find in the IT services sector, which is why the praise heading in the Belfast company’s direction following another profits upgrade is fully justified.

In raising its price target on the small-cap stock to 455p, joint broker Canaccord Genuity said the record of Kainos in organically growing its business at a rate of over 40% merited a "substantial premium rating".

Investec Securities agreed, with its new 500p price target based on the company remaining a "core sector pick" and underpinned by both strong industry drivers and market position. That implies potential upside of 23% from the current price of 406p following a 15% surge Wednesday.

Source: interactive investor            Past performance is not a guide to future performance

Their comments reflect continued momentum at the start of the new financial year to March, with Kainos saying today it expects to beat market forecasts. This comes three months after the firm racked up an eighth consecutive year of revenues and profits growth.

The company has only been on the London market three years, having floated at 139p in a listing that made millionaires out of staff who had been with Kainos from the outset back in 1986. Shares have trebled since the float, with the stock as high as 445p in June this year.

Kainos claims to be one of the longest standing independent technology companies in the UK, having been set up as a joint venture between ICL (now Fujitsu) and The Queen's University of Belfast.

It now employs more than 1,000 people and is a specialist in digital technology solutions, software design, third-party software integration and implementation, and tech support.

The company's clients are predominantly in the public, health and financial services sectors, with Kainos a leading provider of mobile-enabled healthcare solutions to the NHS.

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Strength in the company's core digital services division continues to impress, driven by the ongoing push of the UK government to digitise its services. Kainos is also Europe's largest boutique Workday partner, helping businesses to implement and optimise their key software.

Investec now forecasts 43% revenues growth in digital services to £112 million, which is 19% higher than it previously expected. This is partly offset by the impact on margins from Kainos having to use sub-contractors and partners in order to keep up with the strong demand.

In the digital platforms division, Kainos Smart has continued its strong growth trajectory but a lack of funding at NHS Trusts has meant further pressure on the Evolve electronic medical records business.

Overall, Canaccord is raising its revenues forecast for 2019 by 15% and earnings per share estimate by 12%.

Its analysts said: "After only four months trading in FY19, we are putting through a substantial profits upgrade and increasing our target price. This reflects our increasing confidence in management’s ability to substantially outperform the competition in digital services.

"To grow a services business at over 40% organically is extremely rare, in our experience, and this deserves a substantial premium rating."

The price target is based on projected price earnings multiple for 2019 of 25.8x, with scope for further upside as growth eventually slows and margins start to rebound.

The current dividend yield is 1.8%, having recently paid out 6.6p a share in a distribution representing 61% of adjusted profit after tax. Kainos ended the last financial year with cash of £29 million, representing a 22% rise on a year earlier.