Sunday, January 23, 2011

NCC Group a Fast Growing IT Security Stock


NCC Group gave interim results last week and they were warmly received by the market. This is a UK based small cap IT company, but before international stock pickers turn away, I suggest taking a closer look. This stock offers a compelling proposition of offering a highly cash generative business model as well as strong secular growth prospects.

Before discussing the results, I want to outline the nature of the company.


A Secular Growth Stock

NCC core business is software escrow. In other words when a company buys some developmental software, it has to carry the risk that the developer could go bust or disappear. Holding the software code in escrow will help to mitigate this risk, because the company can always retrieve it. The defensive nature of this business was put to the test in 2008-10 and it passed with flying colors. NCC was not able to implement the Co's annual price increases, but with this result NCC confirmed that the price hikes are now back.

The second main division is Assurance, and this focuses on the high growth are of information security. NCC have been acquisitive in this area and has built revenues steadily over the years. NCC offers a range of services and cross sells them across the constituent parts. NGS secure sells security testing services. Site Confidence sells web performance and load testing services. SDLC is a UK based testing services provider.
Finally, US based iSEC Partners sells security testing mainly to the US.

The iSEC acquisition is expands NCC presence in the US, where NCC are seeking to also expand software escrow revenues.


NCC Interim Results

I liked these results. Some bullet points

  • Closure of the under performing general IT consulting unit
  • Group orders and renewals at £41m vs. £30.9m last year
  • UK Escrow annual price increases re-implemented with 5% hike
  • Assurance growing strongly due to acquisitions, but underlying profits still rising at 6%
  • Margins reducing because Assurance (lower margin than Escrow) is becoming a larger share of sales
  • High cash flow generation and the current ratio is falling

I think the closure of the general IT consulting unit has been due for some time. NCC reported that

 
The Group's withdrawal from the general IT Consultancy market resulted in a one off exceptional charge of £950,000, of which £450,000 is non cash related.  Total post tax losses from discontinued operations were £1.1m in the period compared to a profit of £182,000 in 2009
This means that the reported results contain losses of £1.1m from attributable profit which makes 3.1p of diluted EPS. The adjusted diluted cash EPS actually rose 24.6% from 12.2p to 15.2 with the trailing EPS at 32.4p giving a PE ratio of 640/32.4=19.7 times.

The disposal is good news because NCC can now focus on growth.


NCC Set for Growth

I've broken down half year historical numbers for Escrow and Assurance here. NCC year end is in May, all data in millions.


Nov 2007
May 2008
Nov 2008
May 2009
Nov 2009
May 2010
Nov 2010
UK Escrow
7.8
7.9
7.9
8.7
8.5
9.4
9.2
Eur Escrow
.1
1
1.2
1.2
1.4
1.5
1.5
US Escrow
.5
.7
.8
1.2
1
1.2
1.1
Total Escrow
8.4
9.6
9.9
11.1
10.8
12.2
11.9
Assurance
5.8
7
7.7
18.1
11.3
19.5
21.1



Clearly, the acquisition led growth in Assurance is shifting revenues towards a lower margin division. Furthermore, it is interesting to note that non-UK escrow revenues have gone from 7.1% to 21.8% in the last two years. This is partly due to the inability during the recession to implement price rises and from the international expansion plan. Nevertheless, growth has been excellent and few IT companies can boast anything similar over the last few years.

Turning to segment profitability
  

Nov 2007
May 2008
Nov 2008
May 2009
Nov 2009
May 2010
Nov 2010
Escrow Profit
4.6
5.6
5.5
6.2
6
7.3
6.7
Margin %
55
58.3
56
55.4
55.4
60.1
56.1
Assur Profit
.8
.9
1
2.6
1.3
2.7
2.4
Margin %
14
13
13
14.1
11.8
13.8
11.5
Total Margin %
38
39.1
36.9
29.8
31.6
32.2
27.6



The reduction in margin can be seen in, however, profits are growing strongly. Moreover, this has always been a highly cash generative business. Trailing free cash flow is 12.1m which puts it on a FCF Yield of 5.6% with strong growth due in the second half. Historically, the second half is stronger and NCC expects the same thing this year. 

Consensus forecasts are for £70.4m in revenues, EPS of 36.6p and pre tax profits of £17.2m with a market cap of £214.5m.  I think this stock is better priced at aroud 710-725p.




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