Should you buy, hold or sell Data#3 shares?
Data#3 (ASX:DTL) was founded in 1977 and listed in 1997. It is a picture of longevity and stability with the previous CEO having retired in March, after 30 years with the company, nine of those as CEO.
His successor, Brad Colledge joined the company in 1995, so is also a veteran of almost 30 years.
It has grown its gross revenue at a compound annual growth rate of 17% for the past five years, meaning it has more than doubled from $1.2 billion to $2.7 billion for the past 12 months.
It is forecast to reach $3.1 billion by 2025. This has been achieved without needing to issue new shares to fund acquisitions. In other words, it is organic growth.
Sticking with the long-term focus, over the last 10 years the share price has risen from $0.69 to $7.43 and it has paid out a total of $1.27 in dividends per share.
This amounts to a return of 28%p.a. over 10 years, more than a 10 bagger.
Data#3 provides IT services to corporate and public sector customers.
It works across a broad range of clients to provide IT infrastructure such as cloud solutions, cyber security, data and analytics and connectivity through projects and ongoing support.
One of its competitive advantages is its strong partnerships with leading global IT equipment and software suppliers. It is the number one partner in Australia for Microsoft, Cisco and HP and a top five partner for Dell.
DTL was selected for the inaugural Stockopedia ANZ Top Stocks portfolio established in January 2023 as one of the two highest ranked technology stocks.
When the portfolio was rebalanced at the beginning of 2024 it retained its position with a Stockopedia StockRank of 94. Since inception of the portfolio, DTL has produced a total return of 13.3%p.a..
The biggest driver of its StockRank is the Quality score of 97. The returns on capital and equity are very high, in the 60s.
This is a very capital-light business with no need to invest large amounts in property, plants and equipment. Its main investment is in its people, but that does not appear on the balance sheet.
Its balance sheet is very strong. It has no financial debt and at the end of December it had $117 million in cash.
The biggest asset by far is receivables at $200 million, but this is offset by payables of $235 million.
Receivables and payables are high at financial year end, but this reflects the seasonality around financial year end. Its working capital cycle is self-funding.
Cash flow also follows this seasonality, and can be quite volatile. Operating cash flow was negative in 2021 and 2022, but exceeded profit by more than seven times in both 2020 and 2023.
In the first half of FY24 the average daily cash balance was $300 million. In the long term free cash flow to assets is 10.7% which is a very solid return.
Whilst the long-term performance has been very strong, the recent past is a different story.
Since the start of 2024 the price of DTL has fallen 10.6%. The catalyst was the release of the half year results.
On the face of it, the results were quite strong, but when a stock is already trading at a high valuation it only takes a small miss for expectations to be reset.
Gross revenue grew by 13.4% and Net profit after tax increased by 25.5%. Gross profit grew by 8.8%.
Where the market was disappointed was in the small contraction in margins. Despite the growth in total gross profit, total margin on gross sales declined from 10.3% to 9.9%.
Overhead costs increased due to wage inflation and increased headcount. Internal staff costs increased 10.1%. Other operating expenses increased by 5.1%.
This highlights the biggest risk faced by DTL which is staff. It relies on more than 1400 people to support clients. High calibre IT staff can command high salaries, so to attract and retain them the company needs to be able to absorb the wages bill.
Fortunately, it can generally factor this into the pricing of customer contracts, but it needs to be managed, especially for longer term contracts.
DTL is a high sales, low margin business. This contrasts with a business like Hansen Technologies (ASX:HSN) which has low sales but high margins.
DTL is a more generalist business providing hardware, and software solutions across a wide range of businesses whereas Hansen is focused on a particular niche in utilities and communications enterprises.
Tight margins mean it is more vulnerable to movements on the cost side of the income statement.
Like most IT businesses at present, its presentations are littered with references to AI.
In its case AI could help to drive growth, not because it is necessarily developing cutting edge AI, but because its clients feel it needs to embrace it and therefore look to DTL to provide the hardware and software solutions.
Client investment in technology is the biggest underlying driver of growth for DTL.
Like many of its IT peers, it is the valuation that gives pause for consideration with Data#3. Despite the recent decline in the share price, it is still trading on a forecast PE of 25.
It pays about 90% of its earnings out as dividends so the forecast dividend yield is high for a tech stock at 3.7%.
Investors need to decide if they believe the recent travails will only be short term, and if so, how much are they are willing to pay to get on board with a high quality, compounding business.
The author has holdings in DTL
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