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Kainos: Eight years of profit growth cannot go unnoticed

Publication Date: 08 Nov 2018 - By Samuel Smith By Samuel Smith
Actionable
Differentiated

Equity Fundamental Equity UK EU ex-UK Technology

Kainos (LON:KNOS) – a rapidly growing digital technology solutions and software firm – is working across its three divisions (digital services, evolve, and workday implementation services) to develop intellectual property that exploits the rise of data and analytics, enabling it to grow its market share and cash flows.

Investors ought to notice the company recently reported its eighth consecutive year of growth in both revenue and adjusted pre-tax profit. Revenues grew 16% year-over-year, sales orders were up 38%, backlog surged by 45%, and diluted earnings per share rose 10%.

The balance sheet also strengthened as cash increased by 22%.Furthermore, continued backlog growth, business diversification driven by international, commercial, and software revenue growth, new Digital Services customers, strong customer retention (thanks to a stellar 99% customer satisfaction rating), and a strong recruiting programme (driven by factors which have given it six consecutive years as one of the Top 100 “Best Companies to Work For” according to the Sunday Times) all point to a vibrant business with a strong growth runway ahead of it. 

Another attractive aspect of the business is that 56% of group revenue is derived from government contracts, while an additional 14% is from the healthcare sector, making it fairly recession resistant.

Digital Services growth has been driven by both digital transformation (+19%) and workday implementation (+40%) initiatives involving the UK government’s digitisation programme alongside growth in commercial clients, aided by expansions into the Frankfurt and Copenhagen markets.

Digital Platforms, meanwhile, received a growth boost from the Kainos Smart automated testing platform, increasing the number of customers by 40% during the year and Evolve sales orders grew 28% thanks in part to the Shared Care project. Evolve also sees promising potential for growth into the US marketplace in the near future.

The three main risk factors facing UK-based Kainos are cybersecurity threats, Brexit, and intellectual property. A cyber breach could significantly damage the firm’s reputation, thereby negatively impacting cash flows. To help mitigate this threat, Kainos has purchased cyber-liability insurance and also implements regular cybersecurity reviews and training sessions for employees.

Brexit should have a decreasing impact over time as growth in its international revenues is significantly outpacing increases in its domestic sales. However, currency exchange risk will remain in place. If Brexit results in long-term damage to the UK economy, a weakened British Pound could eat into foreign-based cash flows.

Finally, maintaining an IP edge is vital due to the increasingly competitive nature of this industry. Larger rivals will be spending heavily on research and development (R&D), making recruiting and retaining top talent and balance sheet management key.

By retaining significant cash over the past year and growing the dividend at a significantly lower rate than revenues and earnings, management is taking prudent steps to ensure it has the resources necessary to compete.

Conclusion: The stock has been on an impressive run and looks a bit pricey right now. It might be best to keep this on the watch list and buy on a pull back.

Disclosure:

I have no positions in any of the securities referenced in the contribution

I do not use any non-public, material information in this contribution

To the best of my knowledge, the views expressed in this contribution comply with UK law

I agree with the terms and conditions of ReachX

This contribution is for informational purpose and does not constitute investment advice nor is it an offer to sell or buy, nor is it a recommendation for any security.

Samuel Smith

 

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