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MMT is an IT consultancy, services and software provider. The group concentrates on a large blue-chip client base and mainly focuses on providing a variety of broadly based IT solutions to the general retail, insurance and banking industries. MMT also develops software for commodity derivatives trading, the supply of electricity and health trust pharmacy systems.
Moving to the finances. Here's the financial record that initially attracted me to MMT.
No doubt you've spotted the sudden earnings slowdown in 1999. In fact, if it wasn't for a lower tax rate and other investment income, earnings would have decreased slightly last year. Until 1999, with the help of a handful of acquisitions in the last two years, revenues and earnings trotted along at a fair old pace. Stripping out rough annualised estimates of acquired revenue, the underlying rate of continuing sales growth over the last three years has been 21%, 33% and -4% for 1997, 1998, and 1999 respectively. Using these underlying growth rates, 1996 revenues of £16.86m would have organically grown to £26.05m in 1999.
Up to and including 1998, profit per employee ran at a faster rate than the average wage per employee. All very good. But, although MMT commendably increased profit per employee marginally in 1999, staff costs ballooned. Although nothing is stated in the latest annual report, one explanation could be a hefty redundancy bill, implied by the reduction in the head count at MMT during 1999.
As you can expect from an asset light "people" business, return on average equity is high.
The "fixed asset-lightness" can be seen with the capital expenditure required over the last few years, comparing this expense with operating profit.
Where MMT loses out, though, is in the working capital stakes. There has been an increasing, and worrying, demand for cash in this area. To a certain extent, working capital will never be an MMT strong point. The group's main expenditure (staff) is paid monthly. I guess it's fair to say that income from clients is paid to MMT on a "lumpy" basis, leading to periods where MMT have paid their employees, but have yet to receive any client payments. Having a list of blue-chip customers is reassuring towards the inevitable bad debt concerns this working capital profile leads to.
All this investigation is academic if the current valuation of MMT appears to be stretched. The Qualiport is looking for top-notch companies that can be bought at a fair price, or preferably, at a bargain.
I'm already a holder of MMT shares, and ever since I started to write for the Fool, I've been a little wary of pushing the shares I already own into the Qualiport spotlight. So beware of any rose-tinted statements!
Anyway, having seen MMT witness a significant share price decline over the last few weeks, I think it's now appropriate to roll them onto the Qualiport stage. Can MMT clear the Qualiport criteria?
MMT Under The Microscope
Hopefully, you won't need me to tell you that basically anything to do with IT means "growth". Industry expert Richard Holway suggests that the annual rate of growth for the IT services and software industry is around 12% post-Y2K. To remain a leading player in any industry, companies require an ever increasing IT budget, adjusting and replacing systems and hardware platforms to maintain a competitive edge. And with the skills needed becoming all the more technical and complex, companies tend to look towards third party help, rather than their own in-house IT department.
Anyway, this steady stream of repeat business is good news for MMT. By and large, MMT operates in a pretty attractive industry. And it's a familiar and understandable industry also, well for me at least. Having worked ten years in an IT environment, I think I have a pretty good grasp of what generally goes on at MMT. All this means that MMT, in my view, clears the "company you can understand which has predictable earnings" hurdle.
The Financials
To August 31st 1995 1996 1997 1998 1999
Turnover (£m) 13.96 16.86 24.64 36.70 41.02
Operating
Profit (£m) 2.72 3.83 5.04 8.73 8.28
Earnings per
Share (p) 16.3 24.6 29.8 51.6 52.8
Operating
Margin (%) 19.5 22.7 20.5 23.8 20.2
Sales
Growth (%) 28.5 20.8 46.1 48.9 11.8
Earnings
Growth (%) 24.4 50.9 21.1 73.2 2.3
In fact, I'm probably doing a disservice to MMT in only showing the performance of the last five years. The group was established in 1978 and listed in 1983 at a value of £1.2m. The group steadily increased its profits up to 1990, revenues and profits reaching £7.52m and £1.87m respectively in that year. But the early nineties recession put a dampener of the growth record. It then took four years for turnover to rise back above the level of 1990, leaping from £7.06m to £10.86m in 1994. Conservatively starting at the 1990 sales peak, the compound rate of sales growth to 1999, to the £26.05 calculated above, implies an organic sales growth rate of 15.6%. MMT does have a long, quoted and proven history of growth, although it's not been an entirely smooth ride. So, MMT passes the "proven past growth record" hurdle, and with 20%-plus margins, easily clears the "strong margin" hurdle as well.
Staff Productivity
Of course, it was Y2K implications that gave MMT an extra boost in the run up to the Millennium, but on the flip side, it was Y2K again that brought about the halt in MMT's performance. With clients deferring business until after the much-vaunted date change, business became relatively thin on the ground for MMT in 1999.
This had an amplified impact on MMT. The group differs to many other IT consultancies in that it primarily employs full-time staff rather than contractors. Over the last few years, full-time IT staff, although highly paid, have not been as well paid as their contracting counterparts. So, with staff costs being the largest overall expenditure for MMT, it all leads to a high level of operational gearing.
In other words, during the good times, any extra revenues should filter straight towards the bottom line. Conversely, when work dries up, as it has done recently, the relatively fixed costs of employing permanent staff have a severe impact on profits. The "utilisation rate" is the commonly phrase used within the IT industry, reflecting the percentage of staff currently earning money for the company. So, a decline in the MMT utilisation rate after the "exceptional" figure produced in 1998, stifled profits in 1999.
To August 31st 1995 1996 1997 1998 1999
Operating
Profit (£m) 2.72 3.83 5.04 8.73 8.28
Staff Costs (£m) 9.90 11.60 18.47 25.01 30.56
Number of
Employees 296 322 454 605 552
Profit per
Employee (£000) 9.2 11.9 11.1 14.4 15.0
Cost per
Employee (£000) 33.4 36.0 40.7 41.3 58.5
Return on Equity, Capital Expenditure and Cash
To August 31st 1995 1996 1997 1998 1999
Earnings (£m) 1.86 2.86 3.51 6.15 6.49
Shareholders
Funds (£m) 9.89 11.58 14.62 20.20 23.87
Return on average
Equity (%) 26.6 26.8 35.3 29.5
Incremental return
on average equity (%) 33.1
(All figures adjusted for goodwill written off)
To August 31st 1995 1996 1997 1998 1999
Operating
Profit (£m) 2.72 3.83 5.04 8.73 8.28
Capital
Expenditure (£m) (0.29)(0.77)(0.53)(0.75)(0.56)
Change in
Working capital (£m)(0.03)(0.25)(2.16)(3.18)(2.78)
Although having a rather cash-hungry working capital character, MMT operates without recourse to any debt and had £8m cash in the bank at the end of August 1999, representing a nearly a third of shareholders' funds adjusted for goodwill written off. MMT aren't going to go broke anytime soon, but I think an eye has to be kept on the cash generation. MMT passes the "high return on equity" hurdle, and although not a fountain of cash, a high cash balance helps MMT to scrape the "strong cash generator" hurdle.
Valuation
The average of this year's earnings estimates, given by the four brokers who have expressed a forecast since the full-year results announcement in November, is 47.05p.At 692.5p, MMT currently stand on a forward price to earnings ratio (P/E) of 14.7. Those same brokers put forward earnings-per-share (EPS) estimates of 57.44p for the year to 31st August 2001, leaving MMT on a P/E 11.9 eighteen months out. With MMT under 700p, and just using the basic P/E ratio, we're not really talking of overstretched valuations.
The company has a great record, although not as great as some of the "higher flying" IT companies. But the record is far better than average, and on this overview I'm going to take MMT forward as a potential Qualiport candidate. The company has suffered from the Y2K slowdown, and I do think that this slowdown could lead to an investment opportunity. Mr Market appears to considering the very short-term flat earnings outlook at present, rather than the long-term potential. Should the Qualiport take advantage of this apparent myopia?
Let us know your thoughts over on the Qualiport discussion board.
Related Links
• MMT website
• MMT Discussion Board
Note
The Qualiport was launched on December 19th 1997 with an initial investment of £4040.63, all in Rentokil Initial. Further cash was added as holdings in Emap, Marks & Spencer and Unilever were bought during 1998. The vagaries of the value per share accounting method caused percentage return calculations for calendar 1998 to be somewhat distorted. To avoid confusion and somewhat misleading figures, the Qualiport's returns are being measured from 1/1/99, at which point the total portfolio value, including cash, stood at £16,809.60. An additional £2000 cash is added to the portfolio on April 1st and October 1st each year. The total cash investment in the portfolio to date has been £20,184.62. To access the Qualiport's total trade history, click here.