SCISYS has revealed that it has been hit by cost overruns at a fixed-price development project. We note this is the group’s first significant problem project since FY07, as it has been managing its projects more effectively since then, having put more rigorous procedures in place. Trading across the rest of group has been broadly in line with expectations. However, SCISYS has also been affected by the recent strength in sterling against the euro. We have cut our forecasts, and SCISYS says it might be in breach of its UK banking covenants. Nevertheless, the business remains profitable at the pre-tax level, has banking facilities in place and a balance sheet supported by sizeable property assets.
SCISYS announced cost overruns at a major fixed-price development project in its Enterprise Solutions and Defence (ESD) division, as “the size and complexity of the project has been underestimated”. We expect the resulting project delay will also impair the group’s ability to deliver on other projects in H215, since more manhours will be needed on the problem contract, and SCISYS will need to recruit more qualified people for these projects. Further, sterling has risen sharply against the euro since end-FY14 and this will also reduce profits. SCISYS says it may breach certain of its UK banking covenants when these are tested in mid-August, but says its principal UK bank remains supportive.
Our revenues are cut by £2.5m in FY15e and by £3.0m in FY16e, while adjusted operating profit falls by £3.0m in FY15e, exacerbated by the one-off provisions, and by £1.1m in FY16e. Despite the downgrade, which we believe is conservative, we expect the group to remain profitable in FY15 and record a healthy recovery in margins in FY16. Tax effects result in a small negative EPS in FY15e. On our new forecasts, the group will swing to net debt of £1.4m at end-FY15 (previously £1.3m net cash) and return to net cash by FY17e. Financial flexibility is enhanced by working capital facilities in UK and Germany and sizeable bank guarantee facilities in Germany. Also, SCISYS owns freeholds which could be sold. These include the group’s HQ, which it sold in 2007 for £9m and repurchased in 2011 for £5m.
The stock trades on 0.4x our FY16e revenues and 5.0x EBITDA. The dip in the share price could, in our view, be an opportune entry point, if there are no additional hits to earnings and if the group’s bankers continue to remain supportive.