Over the last 12 months, the FTSE 250‘s jumped almost 15%. And the total return for passive index investors is even higher at 19.5%, thanks to dividends. But this upward trajectory hasn’t been shared by all of its constituents. Kainos Group (LSE:KNOS), in particular, has been hit hard, tumbling by almost 22% since 2024 started.
However, after digging a bit deeper, I discovered a potentially lucrative long-term buying opportunity for my portfolio. If I didn’t already hold it, I’d buy now.
What’s going on at Kainos?
As a quick reminder, Kainos is an expert in digitalisation, helping businesses integrate technology-driven solutions to automate processes and improve efficiency. The firm’s long stood out as a high-growth enterprise that seems to print money when looking at free cash flow margins. It’s why shares have historically traded at a lofty premium. But sadly, premium valuations and slowdowns don’t tend to mix well.
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Higher interest rates and inflation were already dampening demand as businesses cut spending to save money. However, with Kainos also serving the public sector, the uncertainty surrounding the October Budget only increased the headwinds.
Consequently, many of its clients have been delaying projects and capital commitments. This ultimately translated into two guidance cuts throughout the year. And looking at the group’s recently published interim results, revenue’s indeed fallen by 5% to £183.1m year-on-year, with bookings falling 11%.
The buying opportunity
Seeing the top line move in the wrong direction is obviously frustrating. However, when zooming out, most of the headaches management’s dealing with seem to be external as well as temporary.
The group’s contracted backlog’s actually up 8%, reaching £354.1m. So when market conditions improve, revenue growth could come back with a vengeance. Meanwhile, cash flow generation’s still jaw-droppingly strong, with cash rising by 21.3% to £137.1m. And management’s using this liquidity and its depressed share price to buy back £30m worth of shares over the next six months.
In the meantime, profit margins are actually rising. The Workday Products division has bolstered gross margins to 78.4% from 75.7%. That’s particularly encouraging since it’s currently the only part of Kainos’ business that remains in full-growth mode, with revenue up 28%. What’s more, management expects this upward trend to continue well into 2025 and beyond.
The performance of its slower-moving segments is expected to remain subdued while customers continue to minimise spending. And management has warned that the headwind of slow decision-making from the British government could last until March 2026.
However, there have been some early signs of improvement throughout the sector, indicating that activity’s slowly ramping back up. And with the long-term trajectory of Kainos still intact paired with a cash-rich balance sheet, this temporary weakness looks like a buying opportunity for patient investors to consider, in my opinion.
