2020 has been a strange year for the FTSE 100. Sharp rises and falls in the market have occurred whenever news is released regarding Covid-19. However, while many businesses are feeling the impact of the pandemic, this tech stock has been flourishing — increasing by nearly 120% in one year!
An opportunity to beat the market?
Kainos Group (LSE:KNOS) is a digital platform and services company. It provides IT consultancy to a wide range of FTSE 100 businesses as well as the UK government.
The firm uses cloud-based technologies to run software services. Since its employees were able to easily work from home, the performance impact from Covid-19 has been negligible.
Its revenue stream comes from two segments of the business – digital services and digital platforms.
The first focuses on increasing the cost-effectiveness of organisations that primarily operate within the public, commercial, and healthcare sectors (including the NHS). The central government is also working with Kainos across multiple departments – such as the Commonwealth Office, Home Office, Land Registry, Department for Environment, and many others.
The second segment is the cloud platform side of the business. The firm sells a range of software solutions all designed to reduce inefficiencies within the healthcare sector. The technology is behind the digitalisation of NHS patient records and the automation of healthcare delivery.
In 2010 the company began to develop a strong relationship with the American software vendor Workday. Kainos has expanded the base capabilities of the software to allow for direct consulting, project management, remote integration, and post-deployment services for its clients.
The financials
Clients regularly pay for the consultancy services, as well as annual licensing fees for their software solutions. This means that revenue is generated almost entirely from repeat sales to customers.
With companies closing offices to keep their employees safer, the need for the Workday platform has only increased. This presented an incredible opportunity for Kainos to expand it long client list.
The most recent interim results saw top-line revenue grow by 23% to £107.2m. This strong performance originates from double-digit growth across all its sectors. International, Commercial, and Healthcare revenues rose by 54%, 34%, and 73%, respectively.
Seeing this level of growth is quite impressive. However, what I’m excited to see is the operating profit margin almost doubling from 14% to 22%.
By already having a business infrastructure in place, combined with favourable market conditions, the proportion of operational costs remained constant. In other words, Kainos was capable of transforming most of this new revenue directly into profits.
The bottom line — can it beat the FTSE 100?
Seeing the firm double its underlying profit in only six months is quite an achievement. While I think it’s unlikely that this will occur again, the margin increase has made the share price more justified in my eyes.
Assuming the business can maintain its current growth rate over the next six months, I would expect the pre-tax profit to be around £50m. This would be the equivalent of a forecasted price-to-earnings ratio of 35.
It’s certainly not a cheap stock, but with more companies needing to undergo digital transformations, I believe this stock is on track to continue outperforming the FTSE 100 Index.
