High valuations are nothing new in the tech sector. Indeed, the scores of companies operating in the online marketplace in particular carry elevated earnings multiples as investors expect the increasingly-connected world to deliver exceptional bottom-line expansion in the years ahead.
Online security specialist NCC Group (LSE: NCC) is one such company.
But sky-high valuations often leave these companies in severe danger should their route to gargantuan profits growth suffer a puncture. And this has been the case for NCC in recent months. A shock profit warning on Tuesday sent the internet play to four-year troughs.
The stock is now dealing at a 68% discount to October’s record peaks of 307.6p per share. But is now a good time for contrarian investors to pile in?
Much work to do
NCC warned this week that full-year adjusted EBITDA would come in around 20% less than it had guided in December. The business forecast earnings of between £45.5m and £47.5m just a couple of months ago.
It advised that “the rate of sales growth and subsequent delivery in the Assurance Division in the third quarter to date has been lower than had been anticipated in both Security Consulting and Software Testing and Web Performance.” The unit has suffered from weakness across UK, continental Europe and North America, NCC advised.
The company had already warned of “three large unrelated contract cancellations, a large contract deferral and difficulties with some managed services contract renewals” at its Assurance Division in October.
With conditions seemingly becoming ever-more challenging, NCC said that it would be carrying out a comprehensive review of its operating strategy, including “a review of all of the Assurance businesses, how they operate and how they sell.”
And it added that it would look at how its assets can be better deployed and utilised “given that the significant and planned rise in central and divisional operating costs this financial year has not produced the anticipated improvement in sales.” And the board plans to draft in a team of external consultants to help with the work.
Too much trouble?
There is clearly a lot of uncertainty surrounding NCC and, despite this week’s further share price downleg, I reckon investors should be braced for further pain down the line. The company currently plans to update the market on the progress of its review “no later than July,” results from which could send the stock sinking still further.
The City expects the tech play to endure a 16% earnings slide in the year to May 2017, resulting in a P/E ratio of 12.7 times. This is well below the benchmark of 15 times considered attractive value (at least for a conventional standpoint) and represents a considerable discount from levels seen just a few months ago.
But while some investors would point to sunnier earnings projections further down the line — NCC is anticipated to punch growth of 20% and 14% in fiscal 2018 and 2019 — the scale of trouble at the firm could see these estimates getting hefty downgrades.
I reckon there is very little to encourage investors to pile into NCC right now, and particularly at current share prices.
