Great British Business: Technology

Xchanging primed for profits surge

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Xchanging primed for profits surge
Business outsourcing firm Xchanging (XCH) has changed over the past few years, and much of it for the better. Indeed, while revenue has suffered in the short-term, the company's expected trading outcome for the full year remains unchanged, and a return to revenue and profit growth in 2015 looks almost odds-on. If that happens, the shares look undervalued.

Xchanging's target for this year was always to match 2013 adjusted operating profit, despite starting from behind after exiting certain business last year. Ending the UK HR deal with BAE Systems (BA.) and winding down so-called enterprise partnerships shifts emphasis away from a few big customers to lots of smaller contracts.

A Competition & Markets Authority investigation into the company's July acquisitions of Agencyport Europe and Total Objects has taken up lots of time (we'll get the results next month). Investec Securities trims revenue forecasts by 6% both for 2014 and 2015, but still expects double-digit growth.

What's more, profit forecasts remain unchanged. Look for adjusted pre-tax profit of £52.9 million this year, then £64.2 million in 2015 and £77 million the year after, says the broker.

And why not?

The procurement business has seen a "significant" sales success in the second half of the year, and both Insurance Services and Financial Services continue to perform well. That offsets much of the impact of last year’s sale of Transaction Bank. There's plenty of interest in the Xuber insurance software products, too, although it’s taking a bit longer than expected to nail down contracts. After trials with insurance giant RSA (RSA), the company also launched its insurance accounting and net settlement service Netsett in September.

Management is certainly backing the business. Despite surging by over a quarter since the summer, Chirag Shah, head of the procurement division and founder of MM4, last month spent over £200,000 on shares at 179p. A month earlier, chairman Geoff Unwin splashed out £92,000 at 185p.

Investec, which expects earnings per share (EPS) growth to average 26% for 2015-2016, says:

This is a reassuring update by management and we leave our profit forecasts unchanged. The share price has performed strongly over the past 12 months, reflecting increased confidence in the growth trajectory for FY15 and recognition of its more value add outsourced offering. However, on c.14x FY15E EPS, we still believe the shares look good value and reiterate our Buy.

Strip out forecast year-end net cash of over £83 million (34p) in 2015, and Xchanging trades on just 11 times forward earnings. Margin improvement and firepower for earnings-enhancing acquisitions sweeten the investment case.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.


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