Accenture: Solid Investment Again (NYSE:ACN)
During the last twelve months, I have published two articles about Accenture (NYSE:ACN) – one bullish in June 2021 (with the stock price increasing more than 45% in the following months) and one not so bullish article in December 2021 (with the stock price declining almost 30% in the following months).
With Accenture declining steep in the first few months of fiscal 2022, it makes sense to take a closer look at Accenture to answer the question if the stock might be a good investment again. My opinion about the fundamental business did not change over the last few quarters and is the same as presented in the last two articles. What has changed is the stock price and the calculated intrinsic value – and these fluctuations mostly determine if I am rather bullish about Accenture or not. And right now, it is also the question if we are headed towards a recession in the foreseeable future or not. In the following article I will therefore focus on two aspects – the question if Accenture can manage the (probably) upcoming recession and if the stock is fairly valued or even a bargain again.
Will Accenture Manage A Recession?
When looking at the last results Accenture reported, it almost seems absurd to talk about a recession. In the first half of fiscal 2022, Accenture could increase its revenue from $23,850 million to $30,012 million resulting in 25.8% top-line growth – an impressive number for a mature business. Operating income also increased from $3,544 million in the first half of fiscal 2021 to $4,496 million – 26.9% YoY growth. And diluted earnings per share improved from $4.55 to $5.32 – 16.9% YoY growth.
Growth was also well diversified across the different industry groups and Accenture could also improve its operating margin a little bit.
When reading articles right now, many commentators on Seeking Alpha are assuming we are already in a recession. While I don’t think this is correct, I assume we are headed towards a recession (probably in 2023) and while I assume the U.S. stock market (represented by the major US indices S&P 500 and Dow Jones Industrial Average) will see a final bullish wave, we should not be blind to what might come next: a severe recession in combination with a severe bear market. And as long-term investor I am not interested in making a quick buck over the next few months but invest in great businesses at a reasonable price.
When considering the business model of Accenture (service company specialized on IT services and consulting) one might assume that a recession will hit the business rather hard as consulting services are often discontinued by companies in a recession and one of the austerity measures. However, when looking at the data we have from past recessions, Accenture seems to be an exception. The 2020 recession is barely visible when looking at revenue and earnings per share and as a result of the Great Financial Crisis, revenue declined about 13% and earnings per share declined about 16% – but that is less than one would expect.
The stock price also performed better than the S&P 500 during the Great Financial Crisis.
One reason for this solid performance even during recessions might be the wide economic moat Accenture has, which is preventing customers from leaving Accenture even in challenging times. The switching costs that arise are based on a bond of trust that is formed as well as learning costs. In a previous article about Accenture I described this in more detail:
“On the one side, we might see personal relationship costs as the customers are forming a bond of trust with Accenture and especially if the customers are dealing with the same employees from Accenture again and again this relationship can be very strong. But the switching costs are rather resulting from learning costs, which are high as it takes quite some time for Accenture and its employees to understand the business and get the necessary knowledge in order to provide valuable consulting services. And especially after relationships have lasted for several years, Accenture has gained a lot of knowledge about the customers and often has a good understanding of the business. When switching to another consulting firm, this (steep) learning curve has to be duplicated, which is leading to high costs for the customer.”
In fiscal 2021, Accenture reported that 98 of the company’s top 100 clients have partnered with Accenture for more than 10 years, which is a good sign for long-lasting contracts. However, it is no guarantee that contracts won’t be terminated in a severe recession. And especially the consulting contracts are rather short-term and can be terminated on short notice. Accenture writes in its 10-K:
“Many of our consulting contracts are less than 12 months in duration, and these contracts typically permit a client to terminate the agreement with as little as 30 days’ notice. Longer-term, larger and more complex contracts, such as the majority of our outsourcing contracts, generally require a longer notice period for termination and often include an early termination charge to be paid to us, but this charge might not be sufficient to cover our costs or make up for anticipated ongoing revenues and profits lost upon termination of the contract. Many of our contracts allow clients to terminate, delay, reduce or eliminate spending on the services and solutions we provide.”
The economic moat will protect Accenture in the next recession, but we should not take this as a guarantee that the business won’t suffer in case of a severe recession.
Is Accenture Fairly Valued Again?
I already mentioned above that the question if Accenture was a buy or not was mostly dependent on the stock price and the current valuation of Accenture (as the underlying business didn’t change much). And after valuation multiples increased to rather high levels in 2021 (P/E ratio peaked at 43 and P/FCF ratio peaked at 37), both valuation multiples came down to more reasonable levels again. Right now, Accenture is trading for 28 times free cash flow and 26.5 times earnings. But when comparing to the average valuation multiples of the last ten years, the stock still seems not cheap. Average P/E ratio was 23.4 and average P/FCF ratio was 19.63.
Aside from looking at simple valuation metrics, we also calculate an intrinsic value by using a discount cash flow calculation. And we will provide three different scenarios – a bull scenario, a bear scenario, and a base case scenario. As basis for all three calculations, we take the free cash flow Accenture is expecting for fiscal 2022 (according to its guidance): Free cash flow is now expected to be between $8.0 billion and $8.5 billion and we will take midpoint of guidance ($8,250 million) for our calculation. Additionally, we assume 650 million outstanding shares and a 10% discount rate.
Bear Case Scenario
Let’s start with our bear case scenario and we assume a severe recession for the next year that will also affect Accenture and free cash flow will decline 50% in fiscal 2023. We assume this will be followed by a solid recovery (50% growth in fiscal 2024, 25% in fiscal 2025, 10% in fiscal 2026). And in the following years we assume growth will slow down to only 5% till perpetuity. This would lead to an intrinsic value of $228.65 for Accenture.
Bull Case Scenario
In our bull case scenario, we assume that Accenture won’t really be hit by a recession. We assume stagnating free cash flow in fiscal 2024 and from fiscal 2024 going forward Accenture can continue to grow again. For the following years we assume 10% growth followed by 6% growth till perpetuity (in ten years from now). This will lead to an intrinsic value of $386.89 for Accenture in our bullish scenario.
Base Case Scenario
In our base case scenario, we assume 20% decline for fiscal 2023 (due to a recession) followed by a 20% recovery in fiscal 2024, 15% growth in fiscal 2025 and 10% growth in fiscal 2026. For the following years we assume growth slowing down to 6% till perpetuity in 10 years from now. This would lead to an intrinsic value of $318.54 for Accenture and the stock still seems to be undervalued right now.
In my opinion, the stock will move higher over the next few months (in line with the overall market). I have not pulled the trigger on Accenture yet, and I probably won’t buy the stock during the next few months. Accenture seems to be slightly undervalued right now, but I would be rather cautious as we seem to be heading towards a recession and a (brutal) bear market. And although Accenture has performed quite well during past recessions, we can’t be sure this will also be the case in the future.
I also think the market has provided us with several different bargains in the last few weeks – see my article “Identifying Opportunities in Turbulent Times” – and I think we can buy similar high-quality businesses for a better price.