Axis Shield Trading Statement

Axis Shield gave a trading update today which can be found here. It was met with somewhat of a relief rally in the stock price. I’m in two minds about this being a stock to buy. Frankly, I think it is good value longer term but it is susceptible to short term earnings driven weakness and, I normally shy away from such situations.

If you send me your email address marked ‘Axis Shield’ I will reply with a pdf of a research report I have on the company.

Axis Shield is an interesting stock because it has a whole host of drivers or themes to its prospects. Whilst the main growth driver will be the Point Of Care division and, in particular Afinion, the bulk of ASD profits are generated by their Laboratory Division and that appears to be under pressure.  I’ll come back to that point but first I want to look at the three divisions in the context of this trading statement.

Point of Care Holds Axis Shield Growth Catalysts

Firstly, looking at Point of Care the earnings catalysts are

• Diabetes growth
• Emerging markets growth, mainly through Nycocard
• Growth in point-of-care diagnostics, expanding Afinion sales
• CRP flu testing (defines if flu is viral or bacteria) seen as vital in order to reduce antibiotic prescriptions
• New Afinion test approvals

Now, in this latest update they were 600 short of the 3500 new global Afinion instruments they thought they would have in place. For future reference, here are analyst forecasts for future Afinion sales

	2009	2010	2011E	2012E
Total Systems	6,700	9,600	12,200	14,700
New Systems	2,700	2,900	2,600	2,500

Afinion sales were disappointing. In March 09 they had bought back distribution rights from Abbott Diagnostics for Afinion and had made optimistic noises. Moreover, even up until their trading statement of Oct 28 they were affirming that they were on track for 10,000 but according to the half year report they only had 7,700 at that stage. Note that this statement saw them subtly adjust the target down from 3,500 new systems.

So, with today’s statement, they are telling us that in two months, they fell 400 short of the 2300 (for the half year) they were ‘on track’ to achieve in the Oct 28 statement.  

I am not satisfied with this level of guidance and this is not the first time!

Earlier this year in the finals given on March 16 they said…

We continue to see exciting opportunities for growth across the business, both organically and through complementary acquisitions, and we look to the future with confidence.  We anticipate further progress in 2010

Then on May 10^th they warned on profits

As a result revenues for the 18 weeks to the end of April 2010 are slightly above those for the same period in 2009 (adjusting for the sale of Plasmatec) but are lower than the Board's expectations.  Should these trends continue throughout 2010, this would result in a material shortfall in Company revenues and profitability compared to Board expectations.

Note that March 16 is 12 weeks into the 18 week period when suddenly ‘growth’ becomes a potential ‘material shortfall’. I appreciate that the strength of the flu season is always uncertain and Jan/Feb tends to be the worst months but how could they have not known that it was going to be a benign season by March 16^th?

With regards Nycocard they stated results would be slightly lower, but short term prospects will be guided by the 2010/11 flu season.

Laboratory Division

Following this reference in the October statement…

The pipeline of novel tests in the Company's Laboratory Division is developing well although the usual commercialization strategy on the laboratory platforms of Axis-Shield's global partners may be affected by some tightening of their external development expenditure coupled with the ongoing sector consolidation and resultant system rationalization

...there was cause for concern but they reported ‘stable’ revenues. However, I think that this division still presents potential for short term weakness. At the last finals, it represented 104% of segmental operating profits. Any change in demand, or contracts lost due to customer consolidation will cause significant damage to Axis Shield’s profitability.

Direct Distribution

This is an odd division, as it is low growth and low margin but yet serves as a conduit for generating sales for Afinion and Nycocard, in the Nordic regions. They see growth in that respect, but third party sales are predicted at the same level.

Frankly, they haven’t been able to generate margin growth in this division in recent years. Furthermore, it looks like third party distribution could even be a ‘loss leader’ for them, in order to generate sales growth for Afinion and Nycocard.

Given that they bought back distribution rights from Abbott in the US, this would suggest that they feel comfortable in expanding PoC sales (alongside PSS) and, without the need to rely on Abbott to sell Axis Shield’s PoC within Abbott’s distribution.

If so, then this represents a diametrically opposed approach to that which they are taking in the Nordic regions. Moreover, hospital budgets are constrained and pricing pressure is inevitable going forward. I can see them selling this business.

Conclusion

In conclusion, longer term, I think growth prospects are good with PoC and Lab divisions. Short term, they are falling behind targets with Afinion. The Lab division is still under uncertainty and Direct Distribution has question marks against its business model. Moreover, this company is not demonstrating the ability to give accurate guidance.

I like their longer term growth prospects, but will prefer to stay out until these short term threats are resolved. There is upside from a severe flu season and resumption to growth, but I don’t like buying stocks in which the uncertainty is rising not falling.

SQS Software Quality Systems Trading Update Should Lead to Analysts Upgrades

SQS Trading Update

SQS Software Quality Systems AG gave a trading statement today. They style themselves as the world's largest pure play supplier of independent software testing and quality management services. I think this is an attractive market to be in because IP (and embedded software) is becoming an ever increasing part of a typical goods value. Therefore, software testing services should be able to grow at a faster pace than IT services in general. I should note that this is a German company but it is listed in the UK market. They report in Euros, so be careful when looking at analyst forecasts.


SQS Managed Service Contracts

The last point alludes to the fact that SQS is still a cyclical play and indeed, they were hit in 2008-09. However, the strategy of the company has been to try and move towards managed service contracts and away from purely project work. The problem with the project work is that it is short term and visibility is low. It therefore leaves SQS to be exposed to the cyclical nature of the economy and to suffering from having consultants under utilised.

Unfortunately, in 2008 they underwent an expansion in consultants at precisely the time when their end markets turned down. They learnt the lesson and, are now moving towards manged services as well as increasing the portion of their staff in offshore (lower cost) centres. It seems to be working...

The Company has recently won three new Managed Services contracts and extended three existing ones, such that order intake for the Managed Services division has exceeded €50 million in the year to date. A Managed Services contract can be expected to provide improved visibility of earnings and enhanced margins, compared to a traditional project, over the entire life cycle of the engagement, although it may involve lower margins in the initial phases as the majority of work is carried out by onshore consultants during this time.

...and this is a good update. SQS trades at a share price of 195p and a £53m market cap which-according to analyst forecasts- puts it on PE ratio of 10.3x and 8x for 2010 and 2011 respectively. I think that analysts will have to raise forecasts after this update, however a trading update is due in January.


Catalysts for a Re-Rating

There a catalyst for a re-rating due to a reduction in risk due to taking on more longer term managed services contracts. Furthermore, on evaluation grounds it is clearly undervalued. However, investors maybe overlooking the potential for some M & A activity. The management hold the stock tightly, but it's attractions to a bidder are obvious.

Firstly, it provides a high growth niche area of IT services. Secondly, for an Indian IT services company, it would present an ideal way to add scale in Europe and they should be able to increase margins by shifting work to their staff in India. Thirdly, the evaluation is compelling.

I hold a position.