I was doing some research on potential investments in the consulting industry and came across Endava (DAVA). The company was interesting because it is a relatively small player in this space, which could mean big upside should it continue to grow and be successful.
Just a brief background on the company, Endava is a technology consulting firm helping businesses deal with technological change. Technological transformation can be a challenge for many large, established yet older firms as it represents a “new way of doing things”. Older firms may have deeply embedded legacy infrastructure that people within the organization are already used to.
The company uses an approach called the “The Endava Agile Scaling Framework” to collaborate with its clients and jointly find creative and robust solutions for their business. The company specializes in mobile connectivity, automation, big data, AI, cloud delivery among many other technologies. The company’s operations are primarily in Europe with the UK being the largest market at 44.3% of 2020 revenue.
According to the company, the TAM for digital transformation services worldwide is $451 billion in 2019 and is expected to grow at a CAGR of 15% for the next 5 years. The company has 416 active clients with the top ten clients making up 38% of Endava’s total revenue. When it comes to consulting services, these types of services can be “sticky” as customers don’t switch consultants that often. It’s not surprising then that roughly 89.4% of the company’s revenue each year comes from repeat business from existing clients.
The company primarily operates along 3 verticals, namely Financial Services, Telecommunications and Media (“TMT”), and Other verticals. For the fiscal year 2020, 2019, and 2018, Financial Services made up 52.8%, 52.9%, and 56.8% of total revenue. The TMT vertical contributed 25.7%, 27.4% and 28.1% of total revenue in 2020, 2019 and 2018. Other verticals contributed the remaining balances.
A possible risk with the company is that most of its clients are in the UK and in the financial services sector. In the past London was the main financial services hub for all of Europe. However, with the looming Brexit, this may no longer be the case moving forward. I am confident the company can manage this risk, though, given it has offices all over Europe.
The other risk for the company is that it is in a relatively new firm and faces competition from established incumbents and other next-generation IT service providers. Established consulting firms include McKinsey & Company, The Omnicom Group (OMC), Accenture (ACN), Capgemini (OTCPK:CAPMF) and, Cognizant Technology Solutions Corporation (CTSH). The company is a relatively small firm with a $3.52 billion market cap compared to say a firm like Accenture, which has a market cap of $141.4 billion.
However, in the consulting business massive scale isn’t really that big of competitive advantage. This is at its core a people and relationship business, there aren’t any large scale factories or machinery needed. Furthermore, consulting firms are usually managed at the local level so if Endava can get enough brand recognition in its markets there is no reason to believe it can’t compete with the larger firms.
Endava as a newer firm also has a few competitive advantages over the larger incumbents. The company has deep expertise in the verticals that it serves in the sense that it has helped multiple clients adopt cutting edge technology. Traditional IT consulting firms are experts in legacy systems and infrastructure and may not be as agile as Endava. From the company’s 10-k;
Incumbent enterprises have historically looked to traditional IT service providers to undertake technology development projects. Traditional IT service providers are built for commoditized development, integration and maintenance engagements, where cost is key. They can deliver on large scale projects using scaled, cost-effective infrastructure and are generally expert in legacy systems. While some of these traditional IT service providers have invested in capabilities to provide user experience strategy and design, as well as Agile development capabilities, they were built to serve, and remain focused on serving, legacy systems using offshore delivery.
In terms of short-term results, the company wasn’t too affected by the coronavirus pandemic no doubt due to its ability to service clients remotely. Revenue for fiscal Q4 2020 ended June 2020 was £90.5 million an increase of 18.1% compared to the same time last year. Adjusted EBIT was £15.2 million an increase of 12.6% compared to the same time last year.
The company also made a small acquisition this quarter of Comtrade Digital Serves (“CDS”). CDS is a provider of software engineering services with customers primarily in Europe. The CDS acquisition strengthens Endava’s technical capabilities in other verticals, increases near-shore delivery centers, and is expected to be earnings accretive. I expect the company to continue to make strategic acquisitions in the future as it expands its verticals and geographic markets.
Valuation
Looking at the company’s financials, Endava is growing revenue at a rapid rate of 23.2% CAGR for the past 5 years. The company on average also has a relatively healthy 5-year average EBIT margin at 11.2%. The company has £101 million worth of cash and no debt. Given that as a consulting firm, Endava has little overhead expenses I am not worried about the firm’s balance sheet as it can right-size its personnel and operations if needed. The company is currently trading at a forward P/E of 49.91x earnings.
Author calculations
Most analysts are estimating rapid growth for the company with EPS estimates ranging from $1.16 to $1.38. The company has a good track record of beating earnings every quarter and I think there is a good chance the company can hit these earnings. EBIT in 2020 was dragged down by a one-time expense related to a discretionary one-time bonus to staff worth $27.8 million.
Excluding the bonus adjusted EBIT margins would have been 19%. This higher margin should flow into financials moving forward. The company is guiding revenue growth of 18.5% -20% for the next quarter which should flow directly to the bottom line given the company’s Cost of Sales are mostly salaries and are fixed. While it is true the company’s valuations are a little pricey given its rapid growth I feel it is justified. Endava is a buy.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DAVA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don’t know you or your specific circumstances, therefore, your tolerance and suitability to take risk may differ. This article should be considered general information, and not relied on as a formal investment recommendation.