Management says that due to continued strong trading in H2, FY16 revenues and adjusted operating profits are anticipated to be ahead of current market guidance. The group has been benefiting from contract wins while a weakening sterling against the euro has additionally benefited its Space and Media & Broadcast units. Consequently, we have upgraded our forecasts, which comes on top of the significant upgrades we made after the interims in September. Given the potential for margin recovery and the improving growth profile, in combination with a strong balance sheet, we believe the stock looks attractive on c 11x our FY17e earnings.
Management says the improved trading is “a result of additional contract wins, improved efficiency in delivering existing projects and the continuing positive impact of the exchange rate fluctuations in sterling against the euro.” The UK-based Enterprise Solutions & Defence (ESD) division has been more entrepreneurial in winning pass-through revenues (projects delivered by third parties), taking advantage of its prime contractor position on government preferred supplier frameworks to win new business, which is on a higher margin than traditional passthrough revenue. Space has some notable new wins, while M&B has been benefiting from two wins in H1. Sterling fell from c €1.31 prior to the Brexit vote to c €1.21 immediately afterwards and now stands at c €1.16. This benefits Space (some costs are sterling but revenues are in euros) and M&B (most revenues and costs are in euros, albeit the BBC contract has revenues in sterling and some costs in euros). We note that the group partially hedges its euro-denominated cash flows.
We have upgraded our revenue forecasts by 6% in FY16, FY17 and FY18, with gains spread equally across the three main divisions. Our adjusted operating profit forecasts rise by 11% in FY16 and by 6% in FY17 and FY18, and our EPS forecasts rise at a similar rate. We now forecast the group to end FY16 with net cash of £1.9m (previously £1.7m), which rises to £3.8m a year later.
The stock trades on c 0.58x our FY17e revenue forecast and c 6.4x EBITDA, which is attractive given the forecast improving margins and the group’s strong cash flow discipline. Further, SCISYS retains a strong balance sheet that includes the freehold on the group’s HQ, which was sold in 2007 for £9m and repurchased in 2011 for £5m. Our DCF model, which is based on our forecasts and a conservative weighted average cost of capital (WACC) of 11% and an 8.5% long-term margin target, values the stock at 123p, or 26% above the current level.