HITECH GROUP – High growth, very strong cash generating profile paying a fully franked dividend
HiTech Group has delivered record profits in each of the past three years and looks to be heading for another in FY 2019 after a 12% increase in EBITDA in the half year ended 31 December 2018. I recently caught up with CEO, Elias Hazouri to chat about the company’s success.
COMPANY DATA
| Date of Report | ASX | Price | Price Target | Analyst Recommendation |
| 12/06/19 | HIT | $0.097 | N/A | N/A |
| Date of Report 20/02/19 | ASX ST1 |
| Price $0.058 | Price Target N/A |
| Analyst Recommendation N/A | |
| Sector: Industrials | 52-Week Range: $0.670- 1.200 |
| Industry: Staffing & Outsourcing Services | Market Cap: $36.91 million |
Source: Commsec
What do you do?
HiTech provides recruitment and consulting services predominantly in the IT sector. These services range from skills procurement through to complex project management and implementation contracts. Capabilities cover the full range of technologies including networks, cloud services and mobile solutions, data centres, cyber security and digital transformation.
The company has a diverse client base although 90% of its revenue is generated from Federal government departments and agencies. Technology underpins most government work through service delivery, data collection and analysis and policy development but with limited technology capabilities and resources, the government is highly reliant on the private sector for managing and implementing its technology development programs. As a consequence, numerous contracts emanate from government departments each year for short term engagements through to multi-year projects.
Whilst the company’s revenue is overwhelmingly sourced from the Federal government, with each department and agency operating independently, HiTech has a diversified client base and is not overly reliant on any one department.
Given the size and importance of the Federal government, it is not surprising that there are many competitors. Nonetheless, HiTech is one of the top three suppliers on the digital marketplace and its competitive advantages lie in its sharp client and solution focus as well as having a deep, experienced talent pool with the required security clearances to carry out sensitive and classified work in government.
What is the business case?
HiTech has focussed primarily on the Federal government due to the scale of the opportunity and the financial resources available to execute large, long term projects. Whilst the numerous departments and agencies operate independently, their technology programs come under the whole of government digital transformation initiative.
The three strategic priorities of this initiative outlined by the Minister are to make government “easy to deal with”, “to be informed by you” and “fit for the digital age”. I assume that this means enhancing service delivery, better and more effective data collection with advanced supporting secure infrastructure.
I understand that this plan will be executed through a myriad of projects over a long period. It won’t be an overarching program like NBN but rather handled at the department and agency level to meet their specific needs. Accordingly, there are numerous opportunities for HiTech which are likely to be available for some years.
What have you achieved?
Since FY 2015, HITech’s revenue has increased by 76% and EBITDA has increased by 70%. FY2019 is looking promising after strong gains in the interim period. The primary growth driver has been the focus on the Federal government and the benefits of increasing scale. This has resulted in the return on equity rising from 21.6% in FY 2015 to 34.7% in FY 2018.
More significantly perhaps, the company has become a cash generating powerhouse. Debt was always low but cash resources have increased from $1.8 million as at 30 June 2015 to $5.6 million as at 30 June 2018.
Financial strength has enabled the company to pay dividends, at a rising rate, in each of the past three years. The dividend was 8.0 cents per share in FY 2018. A further 4.0 cents per share dividend was declared with the Interim 2019 results.
What are the growth opportunities?
The company has articulated a simple two pronged growth strategy focused on organic and M&A opportunities. A recent company presentation talks vaguely about these opportunities with organic being more of the same in terms of client focus and value proposition but deeper into cloud services and cyber security The Federal government’s digital transformation initiative will provide considerable opportunities in these areas for quite some time.
The company has not publicly fleshed out its M&A strategy other than to say it will “fit the industry and company culture”. I assume that its targets will be in the newer, developing areas of technology where demand is rising sharply in its core market. Again, this would seem to point to cyber security and cloud services. And I would expect any acquisition to offer broadly similar service capabilities as HiTech currently offers being contract management and project implementation. Nonetheless, with over $5 million in cash resources, a debt free balance sheet and access to equity markets, HiTech has the ability to fund a decent sized acquisition.
Financial Overview
HiTech’s financial structure is relatively straightforward and capital light. The company essentially generates revenue from the supply of labour and services and accordingly, its main cost is contracted staff on which it earns a gross margin of 20%. Scale is important in generating a high return on capital, however, the operations are lean as evidenced by the modest operating costs of $1.5 million in FY 2018.
An operating cash surplus of $3.2 million was generated in FY 2018 and another $2.0 million was generated in in the six months ended 31 December 2018 against which capital spending was modest at $101K and $256K respectively.
Of the company’s $9.0 million in total assets at 31 December 2018, $6.1 million was attributable to cash and another $1.7 million to receivables. The only significant liability was payables of $1.3 million. Accordingly, the balance sheet is remarkably strong.
What do I think?
HiTech is one of those quiet achievers. It’s performance over the past three years has been outstanding and just as importantly has proven to be a very efficient user of capital. It is currently, a cash generating machine.
Strategically the company is well placed at the high margin end of the industry (technology services to government) and is delivering a well-honed value proposition. The challenge will be to sustain double digit growth rates and more particularly, effectively execute its M&A strategy. It certainly has the balance sheet strength but that flexibility comes with risks.
Nonetheless for investors, likely double digit profit growth in FY 2019, a price earnings ratio of around 13 times and a fully franked dividend yield of 8.0%, HiTech looks attractive.
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Recommendation Rating Guide
| Recommendation Rating Guide | Total Return Expectations on a 12-mth view |
| Speculative Buy | Greater than +30% |
| Buy | Greater than +10% |
| Neutral | Greater than 0% |
| Sell | Less than -10% |
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