Accenture: Valuation Has Already Priced In The Near-Term Upside (Rating Upgrade)
Contributor since 2024 / 331 Followers
Summary:
- My view on Accenture has shifted from a sell to a hold rating due to improved demand outlook and better macroeconomic conditions.
- The improved macro environment and strong demand for AI and digital transformation investments suggest Accenture will easily achieve its FY25 guidance.
- Despite the positive outlook, Accenture’s current valuation at 27.5x forward PE leaves no room for error, justifying my hold rating.
HJBC
Investment summary
My previous investment thoughts on Accenture (NYSE:ACN) (published in April this year) were a sell rating, as I believed the demand outlook was bleak. The share price moved as I expected, dropping from ~$332 to as low as ~$278 (my target price was $265). Post the 4Q24 results, my stance is that the performance outlook has gotten a lot better for ACN in the last six months. However, ACN valuation has already priced in all the near-term upside, and I don’t see the risk/reward as attractive.
4Q24 results update
ACN reported 4Q24 revenue of $16.41 billion, representing an organic growth of 5%, driven by managed services of 7% organic growth and consulting of 3% organic growth. By geography, growth was seen across all regions, where growth markets saw 9% constant currency [CC] growth, North America saw 6% growth and EMEA saw 2% growth. By end segments, revenue growth was driven by CMT (2% y/y CC), Health and Public Services (11% y/y CC), Products (6% y/y CC) and Resources (3% y/y CC), but was slightly offset by the decline in Financial Services (-3% y/y CC). Adj EBIT margin expanded by 10 bps to 15%, resulting in an EPS from continuing operations of $2.79 (in line with consensus estimates of $2.79). Another key operating metric worth highlighting is strong new bookings of $20.1 billion (21% in local currency terms).
Regarding inorganic growth (M&A) contribution, ACN spent $6.6 billion on M&As in FY24 given the strong deal flow, and management expects M&A to contribute ~300bps to growth with $3 billion allocated to new M&A in 2025 (most of the deals to be back-end loaded). ACN balance sheet can certainly support this outlook, as it exited the year with a net cash position of ~$4 billion ($5 billion in cash and $1 billion in debt).
Demand outlook has improved
A lot has changed in the last 6 months since I wrote about ACN, which, I believe, has made the performance outlook for ACN incredibly better in FY25. The crux of my sell recommendation was that corporate discretionary spending was going to be peer given the elevated rate environment, which forced them to take on a more conservative mindset. However, that concern is now over as the Feds have cut rates and signaled to more rate cuts ahead. This is music to ACN’s ears because all of a sudden, there is a gush of FOMO (fear of missing out) corporates rushing to catch on to their investment’s plans (deals and plans that were pushed back), specifically for investments related to AI and digital transformation (a recent survey by Gartner noted that >90% of CIO believe AI will be implemented in their organizations by 2025).
The data from ACN results also supports my view. In this latest quarter, ACN recorded $1 billion worth of GenAI bookings, which was a $100 million sequential step up from the $900 million saw in 3Q24, and total bookings saw 24% y/y constant currency growth. What is notable here is the pace of GenAI-related revenue growth, as it touched the $1 billion cumulative revenue mark in 4Q24. Consider that GenAI really only started gaining traction a few years ago; this is a very impressive feat. In my opinion, this solid momentum trend is still in its infancy. As corporates become comfortable with adopting GenAI, it opens up a whole new set of opportunities for ACN as corporates need to invest in business model change, adopt relevant digital solutions, ramp up data management policies, etc., which are all necessities to ensure a successful adoption/implementation of GenAI.
One other thing to point out is that sequential demand recovery is seen across all regions and verticals, which suggests that the recovery is broad-based and sustainable (vs. a particular region/vertical that drove all the recovery).
To fully capitalize on this demand, I like that management has ramped up the number of headcounts in the quarter, growing its pool of employees by 3.2% sequentially (adding ~24k more employees). This is the largest sequential addition since 2Q24 on both a percentage and absolute value basis. Notably, given the focus on optimizing cost, I believe a huge bunch of these hires are from lower-cost regions (management noted a lot of hiring is in India). This should have a very positive impact on margins as growth accelerates.
FY25 should be easily achieved
With that, I think ACN should easily achieve its FY25 guidance. Per management, the FY25 guide calls for constant currency revenue growth of 3 to 6% (0-3% organic growth). Given that the macro environment has gotten a lot better, FY24 will be an easy base to comp against, with 4Q24 reporting constant currency growth of 5% (above the midpoint of the FY25 guide) and a very solid book-to-bill ratio in 2H24 (1.25x, which is the highest over the past two decades), I see the bar ACN to hit FY25 as low. Moreover, the low end of the guide incorporates a worsening macro environment, which, I think, is unlikely.
Valuation
As the demand outlook has changed, I have changed my views on ACN valuation too. I now see a strong case for ACN to trade at a premium to its historical average so long as it can deliver upon its guidance, which I think it can. However, it appears that I am one step behind the market as valuation has surged strongly to the current 27.5x forward PE (vs. historical average of ~23x). At this multiple, the market is leaving no room for error as its prices in ACN hitting the high end of its GAAP EPS guide ($12.91 (high-end) * 27.5x = $355). As such, I still remain hold-rated.
When compared to peers, it also suggests little room for ACN multiple to go upwards. Consensus are expecting ACN to growth revenue at high-single-digits, and this is in line with the average of peers (refer to list below). The average forward PE multiple that peers trade at today is ~27x, which is where ACN trades at today.
List of peers include: Grid Dynamics Holdings, Thoughtworks Holdings, Infosys, Globant, Perficient, EPAM Systems, Cognizant Tech Solutions, and Endava.
Risk
At the macro level, a deteriorating IT spending environment could reduce demand for ACN’s services. ACN growth may also see competitive pressure, in terms of pricing, from offshore outsourcing trend (ACN is mitigating this through its strategy to hire more from low-cost region). Lastly, since M&A is a growth driver, if management fails to execute consistently on this front, it could result in negative growth surprises, thereby impacting the firm’s ability to continue to get credit for future M&A.
Conclusion
My view for ACN is a hold rating. I believe ACN demand outlook has significantly improved in recent months, driven by a better macroeconomic environment and strong demand for GenAI related investments. ACN decision to step up hiring also better position it to capitalize on this growth. However, the unfortunate thing is that valuation has already risen substantially, reflecting the positive outlook. Given the current valuation, I remain hold rated.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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