Here is a tech company with unusually reliable earnings.
NCC Group (LSE: NCC) is all about peace of mind, and today it reassured investors with strong annual results.
The Manchester-based business is built around software escrow, which sees it hold critical computer code from its customers' suppliers, via a legal agreement. If the supplier goes bust or breaks its contract, NCC releases the software so that the customer's business can continue without disruption.
Lodging code with NCC is essentially an insurance policy, and the appeal is obvious. NCC also argues that it's non-discretionary spending, due to the 'mission critical' nature of software placed in escrow.
You'd expect such a business to hold up in a slowdown, and that seems to be what's happening.
Revenues, profits and dividend all up
Group revenues rose 31% to £46.8 million in the year to 31 May, with adjusted pre-tax profits rising 17% to £12.3 million.
Adjusted diluted earnings per share rose by 17% to 26.1p per share, while pre-adjusted profits rose 21%.
With the company throwing off cash -- the cash conversation ratio rose to 140% -- and debt of just £5.6 million due be repaid next year, NCC hiked its full year dividend 32%, to a well-covered 9.25p.
Growth across all divisions
This is no flash-in-the-pan performance, either. According to NCC's own figures, revenues have grown at an annual compound rate of 25% over the past five years, and adjusted operating profit by 22%.
Besides the core escrow business, NCC has expanded into website security, offering anti-hacking testing and services to evaluate how a website performs under stress.
These complementary divisions now represent 55% of revenues -- up from 50% last year -- and add some welcome diversity. The Assurance Testing division is doing particularly well, growing revenues by 49%. Margins aren't as good as with escrow though, and revenue is not so dependable.
Impressively, NCC breaks down its outlook for 2009/10 with some pretty detailed forecasts:
- Group Escrow renewals forecast to be £14.9m (2009: £13.6m)
- Group Escrow verification order book £2.0m (2008: £2.0m)
- Assurance Testing order book £9.4m (2008: £7.1m)
- Site Confidence monitoring renewals forecast to be £4.1m (2008: £3.8m)
That tots up to £30 million potentially already in the bag for next year -- two-thirds of NCC's revenues in the past 12 months.
The nature of NCC's business, particularly escrow, and its performance so far in the slowdown makes me confident this forecasted revenue will materialise. Escrow renewal rates have hovered around 90% for years, with a slight wobble in the first half of last year already having corrected itself.
In terms of new business, NCC estimates the market size in the UK is £100 million, and the company is expanding in other territories, too.
The company certainly sounds confident: "The decisive action taken over the last three years has ensured the Group has and will continue to weather this economic storm and the Board is confident the business will go from strength to strength."
What about the competition?
What worries me about NCC's escrow business is lower-cost competitors taking away its customers. In Warren Buffett terms, where's the moat?
NCC customers aren't buying a tangible product. They are locking away someone else's code, and hoping they never need it. Provided they trust the company holding the data, why wouldn't they choose the cheapest?
NCC's capital expenditure of £1.4 million last year is forecast to rise to just £1.8 million, so clearly there's no expensive technology barrier. This is a people business -- not the best moat.
Addressing these issues, NCC stresses it's the world's largest provider of escrow services and the only one that puts quality ahead of price, adding: "There are no signs that the very small virtual providers who offer a low cost, low value proposition are gaining traction in the market. The Board believes their future is in jeopardy as the market shows no sign of wanting to make false economy by trusting part of their disaster recovery and risk mitigation plans to unknown organisations."
This is what you'd expect NCC to say, and it makes some sense. But the way companies are moving to online web solutions (so-called Software as a Service, such as Google Mail) shows the landscape is constantly changing.
Furthermore, if its software escrow market goes from niche to mainstream, what's to stop a company with a brand name in a related area offering a similar, cheaper service?
This is the big risk with NCC Group, but with escrow contract termination rates running at just 11-12% a year, I accept it's more a worry than a reality so far.
Nice price
NCC still looks like a nice little growth stock with unusually secure recurring revenues (ignoring those competition concerns).
Meanwhile, the big hike in the dividend backs up the board's confident talk, and indicates how shareholders could increasingly benefit from that strong cash generation in the future. The historical P/E is a shade over 12. Today's results beat expectations, and so analysts' forecasts will need revising.
Let's assume the director's confidence is well-founded, and that growth in earnings per share comes in again at 17% next year, which seems reasonably conservative given the 22% compound annual growth rate of adjusted profits over five years.
That would equal earnings of about 30p per share, putting NCC's shares on a forward PE of 10.7, and a forward PEG ratio of 0.63. The historical PEG ratio would be 0.7.
Attractive, especially given the visibility of NCC's earnings. That said, a forward P/E towards 11 isn't bargain basement in today's market.
The price has barely budged following these results. I don't currently hold NCC Group, but if the shares fall below 300p during the summer lull, that may change!
More share ideas from Owain Bennallack:
NCC is a former Champion Shares recommendation -- it was bought in late 2006 and sold in early 2009. You can sign up for a free 30-day trial to Champion Shares today.
