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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Immucor's End Markets Set for Recovery?

Immucor gave results recently and this stock saw a relief rally as investors came into buy. My reading of the earnings results is that top line growth looks weak as blood banks continue to feel cost restraints due to the macro-economy. Not only are blood banks and hospitals seeing funding constraints, but also they are seeing a forestalling of elective surgeries as patients and insurance companies feel the pinch.




Short Term Cyclical, Longer Term Secular Growth


Consequently, Immucor and Gen-Probe are interesting stocks within the health care space for a number of reasons. Firstly,  I see them as benefiting from a cyclical recovery in the economy. Secondly, longer term they will benefit from an increasingly ageing population. Finally, their end markets are less politically sensitive than those of, say, costly drugs getting state reimbursement. Moreover, Gen-Probe has a very exciting molecular clinical diagnostics business. Both companies are highly cash generative, have cash on their balance sheets and offer good longer term prospects. But are they stocks to buy now?




Immucor Q2 Earnings


In the first quarter Immucor disappointed the market be adjusting guidance for their latest automated instrument 'NEO' downwards to 80 to 120 instruments. Similarly, they lowered estimated sales for their older instrument 'Echo' to 140 to 180 orders. In this quarter, they reiterated the guidance

Our instrument orders generated in the second quarter were in line with our expectations. We continue to expect the rate of Echo orders to accelerate in the second half of fiscal 2011. Our fiscal 2011 Echo order expectations continue to be between 140 orders and 180 orders worldwide... ....We continue to expect to generate between 80 orders and 120 orders for NEO worldwide during fiscal 2011

In Q1 they received 26 Echo orders and 18 NEO orders, however in Q2 they received 29 Echo orders and 26 NEO orders.  So there is a pick up in growth in the latest generation instrument. This is positive and could see margins expand in instrument sales, however instrument sales are lower margin for Immucor and not really how they generate income. A quick look at their Q2 sales breakdown...

Fiscal Q2 2011		Fiscal Q2 2010		Revenue Variance
	Revenue	Gross Margin	Revenue	Gross Margin	$	%
Traditional reagents	$ 49,647	81.0%	$ 51,361	76.8%	$ (1,714)	(3)%
Capture reagents	19,029	79.1%	20,005	81.6%	(976)	(5)%
Instruments	11,565	22.6%	10,025	22.0%	1, 540	15%

...reveals that it is the reagent sales that really counts for their profitability. They managed to increase margins via cost cutting measures but with regards to top line growth they declared that

Our outlook for the U.S. market remains unchanged with expected industry weakness throughout fiscal 2011

Now, to a Growth At Reasonable Price (GARP) investor like me those words are chilling, but a value investor might not be so perturbed. Furthermore, as elective surgeries increase along with the economy than Immucor (and Gen-Probe) should do better. In addition, if this is the bottom of their cycle than buying them on a 5-6% free cash flow yield is hardly expensive!




Immucor a Stock to Buy?


All said, I prefer to be a bit cautious here and wait for some kind of confirmation from other sources (Gen Probe etc) as to how the hospitals and blood banks are faring with funding issues and how elective surgeries are performing. Immucor is definitely a stock to monitor, but with the US facing more austerity measures in 2011 I don't the hospitals and blood banks are out of the woods yet. There is still risk that Immucor could disappoint with instrument sales, given the weak outlook for the end customers.