Sword Group: All about high margins supporting dividend payouts

Over the past several years, consulting and solutions outfit Sword Group (EPA:SWP) has experienced rapid growth in both its IT services and software businesses as it continues to expand its global presence, enhance relationships with government agencies, major banks, and blue chip businesses, and drive high profit margins to support its dividend and share repurchase programmes. 

With over 2,000 employees and operations in over 50 countries, Sword offers major multinational corporations and government institutions an expansive global network and expertise in bringing their business and IT systems to what the company describes as a world-class level.

One of its significant competitive advantages is its investment in establishing offices in 18 countries, strategically stationed on all 6 inhabited continents in order to forge close, in-person relationships with clients.

Its software division is not only its most profitable (nearly 30% EBITDA margin in 2017), but it also enjoys strong growth tailwinds from increasing government and corporate investments in cybersecurity.

With strong clients such as the US Department of Defense, major defence contractors, US and UK nuclear sites, and the UK Intelligence Services, management forecasts double-digit organic growth for 2018. Further fueling this growth and ensuring Sword Group maintains its competitive advantage, the business invested over 30% of its total 2017 revenue into research and development.

Though its IT services division is lower margin than the software division (~11% 2017 EBITDA margin), it is the largest and fastest growing segment of the business, representing over 70% of total revenue and projected to enjoy over 14% organic growth in 2018. Showing its commitment to continue growing its international network in this business, management recently acquired two small IT services companies in London alongside another small IT services company in Geneva.

Looking ahead, Sword should continue to experience robust (~10%) growth by leveraging its strong relationships with governments, banks, and blue chip businesses alongside opportunistic acquisitions. In so doing, the outfit will be able to further diversify its revenue streams outside of France. Currently, France accounts for 21% of group revenue, and the figure is projected to decline to only 15% by 2020, as Sword Group expands its global footprint.

Given that the Group's to-date growth rate has been 13%, and its growing global scale amid rising tailwinds for IT and computer security, this seems like a realistic estimate. Furthermore, the current service backlog sits at ~2 years, which means that Sword continues to experience strong demand to fuel its growth ambitions.

However, as the outfit continues to expand into more competitive international markets and into lower profitability adjacent businesses, margins are expected to decline by ~200 basis points come 2020. Additionally, the company’s cash position declined considerably in 2017 (from €32m to €20.6m), potentially limiting its ability to continue funding dividend growth, share repurchases, and/or new acquisitions, especially as profit margins decline.

The share price performance over the next few years will hinge on how well they can manage their cash position, Brexit-related currency volatility (35.3% of revenues are in GBP), and profitability metrics. Given their large, diversified, and stable client base, long-term growth prospects look very strong.