Interactive Investor

Stockwatch: a software share in a sweet spot

22nd April 2022 12:13

by Edmond Jackson from interactive investor

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This company offers growth at a fair price, according to our equities analyst, who believes there’s attractive upside as the story remains compelling. 

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Stock-picking can currently seem like being caught between two stools – highly rated “growth” liable to remain compromised by rising interest rates, and “value” shares that are usually cyclicals potentially facing economic downturn.  

It is therefore quite some relief to read a promising update from a company offering “growth at a fair price”. 

Benefiting from the rise in telecoms investment 

Cerillion (LSE:CER) is a £240 million software provider for billing, charging and customer relationship management. It originated as a 1999 management buy-out from Logica and floated in March 2016 – the summary table below shows consistent if steady financial growth recently gaining momentum. 

The group serves mainly telecom companies, which are currently investing amid the 5G and full fibre roll-out. The pandemic has also created more demand from people working from home. Management contends this is both a short and long-term feature rather than just a phase. 

The business has customer installations across 45 or so countries, and also serves utilities, finance and transportation. Around 72% of revenue is generated from the UK and Europe, 13% Americas, 8% Middle East and Africa and 7% Asia Pacific.  

Last November’s full-year results to 30 September achieved record highs - such as revenue up 25% to £26 million and new orders up 43% to £42 million, while a leap in the operating margin from 13.5% to near 29% helped earnings per share (EPS) to more than double. 

While appropriate to consider if that year was exceptional, it may also imply re-rated prospects for a good while longer. Cerillion has also recently won a “best performing company” award for its software and key performance indicators. 

Latest update affirms strong financial progress

In respect of the six months to 31 March, revenue is up 26% at around £16 million, and adjusted EBITDA (underlying operating profit) up 48% over £7 million. Net cash has soared 114% to around £16.5 million.

The sales pipeline remains strong although management has not upgraded its full-year expectations – the recent consensus of brokers looks for net profit of £8 million on £31 million revenue.  

This would represent 40% growth in EPS, expected to moderate to 20% in the September 2023 year – hence around 820p the stock is on a 27x price/earnings (PE) ratio in respect of this year and 23x next. 

In PE-to-growth terms, it implies a PEG ratio of 0.7 for the September 2022 year and 1.1 for 2023. This key measure of growth stocks can soon vary but sub-1.0 is meant to imply value.  

The table showing that free cash flow per share generally is in excess of EPS lends some comfort – lest “record” performance does prove a peak growth. Furthermore, recurring income grew 25% in the last financial year to one third of group total, which should help support the stock rating. 

The dividend yield is an insignificant sub-1% where you might think the pay-out should be raised given the last two years show earnings cover rising to 3.5x. It could, however, be said that with return on total capital and equity more than doubling in the last financial year, shareholders are better served by retaining earnings. 

Bigger deals with larger customers: better risk/reward? 

Another reason behind the revenue uplift has been an increase in licence revenue recognition derived from increasingly larger customers – hence a 75% increase in software revenue, to constitute 51% of the September 2021 group total. 

Otherwise, services revenue only edged up 5% to 46% of total revenue and third-party revenue slumped 56% to just 3% of the total. This is said to be mainly due to a reduction in low-margin hardware sales. 

Management had trumpeted its largest-ever contract in March 2021 at £14 million equivalent and spread over 10 years, with a Latin American telecoms group. It appeared to trigger a stock re-rating from around 400p over 900p by last July, with the 19 April interims also citing investment to capitalise on strong momentum.

A trend to bigger deals is said to add more active customers, likely to generate higher income in the long run. Moreover, due to a higher software licence element, such contracts tend to be margin-enhancing. 

I would mind that the flip side of bigger contracts can potentially be lumpier revenue – say if one such contract expires before others fully compensate – although Cerillion’s rising element of recurring income quite offsets this. 

Strong balance sheet as a result of cash generation  

Last 30 September there was no bank debt beyond £4.8 million lease liabilities whose net cost shaved only 1% from last year’s operating profit. 

Over £13 million cash plus £10 million trade and other receivables comfortably outweighed £10 million current liabilities – chiefly £9 million trade payables. 

Net assets constituted £20 million, or 69p a share, although this is an inherently “asset-light” business where investors’ main focus will be earnings and cash flow. 

The only thing I find missing is some reassurance on cost inflation. The chief risk would appear to be wage costs if staff are Cerillion’s principal asset: for example, recruitment group Robert Walters (LSE:RWA) has cited professionals’ wage inflation running over 20%, quite whether anything like that applies here. 

An operating margin close to 30% last year does however provide leeway. 

Recent investment includes a new skill centre in Sofia, Bulgaria; and Cerillion 22.1, a latest version of an enterprise software suite for fixed, mobile, cable and multi-service operators, will be launched soon.  

Cerillion - financial summary
Year-end 30 Sep

Turnover (£ million)8.416.017.418.820.826.1
Operating margin (%)
Operating profit (£m)
Net profit (£m)
EPS - reported (p)
EPS - normalised (p)
Operating cashflow/share (p)-3.511.712.517.122.233.1
Capital expenditure/share (p)
Free cashflow/share (p)-
Dividends per share (p)
Covered by earnings (x)
Return on total capital (%)2.412.011.114.813.029.7
Cash (£m)
Net debt (£m)-0.4-1.7-2.5-5.0-2.1-8.4
Net assets (£m)13.013.814.415.516.020.2
Net assets per share (p)43.946.648.952.754.568.8

Source: historic company REFS and company accounts

Some shareholders have locked in gains, but I target £10 a share

Despite the narrative and numbers adding up to an attractive growth story, recently reported share trades involve locking in gains. 

Late last November, the chief operating officer and his wife sold just over 20% of their stake at 836p, raising £117,000.  

Such director sales can quite reasonably relate say to property purchases, and happen in context of a long-term bull trend, although this one followed Gresham House Asset Management trimming its stake from 13.4% to 12.9%. 

Then last February, JP Morgan Asset Management cut from a 3.9% holding below the 3% threshold for disclosures. 

Apart from a same-month purchase of 111,814 shares at 740p for the company’s share option scheme, there have not been any material buys. 

I think this affirms how Cerillion does look overall fairly valued but, given its customer base looks both able and intent on maintaining investment, I regard this stock is an increasingly rare example of how growth is not over-priced nor exposed to current risks in the wider economy. If higher costs exist in the business, they are not at a level reportable.  

The two institutions that have taken profits can be interpreted as reducing exposure towards growth stocks generally, as central banks shift from ultra-loose monetary policy to tightening. 

It has helped to keep Cerillion in a consolidation phase for a year now, although the stock has swiftly rebounded from a drop to 600p in March when the Ukraine crisis broke. 

Barring a market slump, I doubt it will retreat in the near term as the interim results due mid-May will likely re-affirm a strong narrative.  

I target EPS to climb towards 40p and a 25x PE to respect both the growth and recurring elements of income – implying 22% upside to around £10 a share in the next two years. Buy. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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