CGI GROUP INC. $15 (Toronto symbol GIB.A; Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 297.0 million; Market cap: $4.5 billion; Price-to-sales ratio: 1.2; No dividends paid; SI Rating: Extra Risk) is Canada’s largest provider of computer-outsourcing and information-technology services. It also operates in 15 other countries. Canada provided 57% of CGI’s revenue in its latest year, followed by the U.S./India (36%) and Europe/Asia (7%). CGI’s main businesses are:
1) Outsourcing: CGI takes over all or part of a client’s information-technology and related functions. That lets the client cut costs and gain ongoing access to the most current computer technology. Outsourcing accounts for 60% of CGI’s revenue.
2) Consulting: In addition to technical expertise, CGI aims to ensure that its consultants have knowledge of the business issues in their clients’ industries or sectors.
3) Systems integration: CGI brings together a client’s new and existing computer hardware, software, information and telecommunications systems.
CGI’s revenue fell 5.7%, from $3.7 billion in 2005 to $3.4 billion in 2006. (CGI’s fiscal year ends September 30.) BCE Inc. is CGI’s largest customer (12% of revenue), and it bought fewer services. Revenue rebounded 11.8% to $3.8 billion in 2009.
Earnings fell 20.4%, from $0.49 a share (or a total of $219.7 million) in 2005 to $0.39 a share (or $143.8 million) in 2006. Earnings then rose steadily to $1.02 a share (or $315.2 million) in 2009.
Unique software gives CGI an edge
CGI spends just 2% of its revenue on research. However, it buys computer and other hardware from established manufacturers, so most of this money goes to developing new software. Creating specialized software for its clients makes it difficult for them to switch to a rival outsourcing firm.
The company follows a two-pronged growth strategy it calls “Build and Buy.” The “Build” part refers to expanding relationships with its existing clients and attracting new ones.
The company’s outsourcing contracts typically last 5 to 10 years. That gives it steady, predictable revenue streams. Long-term contracts also give CGI a chance to build customer loyalty, and sell more services to its existing clients.
Stable clients produce steady revenue
Another way the company cuts its risk is by focusing on industries that tend to remain stable no matter what the economy is doing. These include government services, health care and telephone utilities. CGI gets half of its revenue from clients in these industries. Banks, retailers and manufacturers account for the other half.
In fiscal 2009, CGI signed $4.1 billion of new contracts and renewals. That’s equal to 106% of its 2009 revenue. As of September 30, 2009, CGI’s backlog of signed contracts was $10.9 billion, with an average remaining contract term of 6.3 years.
The economic rebound is pushing up demand for CGI’s services. In the three months ended December 31, 2009, it won $1.1 billion of new contracts from North American financial institutions. New business accounts for 90% of these contracts, as opposed to extensions of existing deals.
Acquisitions play a big role
The “Buy” part of CGI’s strategy involves making acquisitions. The company cuts the risk entailed in buying other firms by focusing mainly on smaller companies that enhance its products or expand its geographic presence.
The company has made many acquisitions over the past few years. These have raised its goodwill to $1.7 billion, or a high 38% of its market cap. But CGI’s goodwill is less risky than it appears, because it focuses on small companies in a variety of industries and locations. That cuts the risk of a big writedown against earnings.
As well, customer relationships represent much of CGI’s goodwill. Because the company operates under long-term contracts, this kind of goodwill should be durable. As long as the company treats its customers well, it’s likely to hang on to most of them.
Strong balance sheet a plus
CGI’s balance sheet is strong, despite its acquisitions. Its long-term debt is just $265.3 million, and it holds cash of $343.4 million, or $1.14 a share. That gives CGI flexibility to keep expanding. It is particularly interested in the U.S. and Europe.
The company is using its strong cash flow to buy back shares. In fiscal 2009, it repurchased $99.9 million of its shares.
CGI will likely earn $1.10 a share this year. This means its shares trade at 13.6 times earnings. That’s cheap in light of its large, high-quality clientele and improving growth prospects. The company should also gain from falling computer hardware costs and the increasing complexity of software.
CGI Group is our #1 buy for 2010.
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