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Morningstar | CGI Reports In-Line 3Q, With Consulting Shift Positive Indicator; Shares Overvalued

CGI reported third-quarter results that were in line with our expectations. The firm continued to book business at a healthy level, with digital-related work driving a quarterly book/bill ratio of 118% (114% on a trailing 12-month basis). We continue to see digital services growth influence the firm’s business mix too, with systems integration and consulting being 53% of quarterly sales (digital work is more correlated with consulting), which is a considerably higher proportion than a year ago when it was 47%. We see systems integration and consulting as the tip of CGI’s digital services spear when entering into agreements with clients and expect this to lead to follow-up work associated with outsourcing, which is both sticky and long-dated. With over $1.5 billion in readily available liquidity, CGI should be able to maintain its build-and-buy growth strategy in the fragmented IT services industry. Metro market acquisitions will be a focus (with annual revenue under $500 million) and we think the United States, France, and Germany will be geographies of interest. Still, CGI’s management hasn’t ruled out large transformational deals and has mentioned that it is in discussions. As a result, we wouldn’t be surprised to see CGI make a significant structural move over the next few years. In the meantime, we reiterate our CAD 65 ($50) fair value estimate and narrow economic moat rating. With the shares at a premium, we’d seek a wider margin of safety before investing.

For the third quarter, reported revenue rose 3.7% year over year to CAD 2.9 billion (3.8% in constant currency). Management said it sees clients increasingly looking to address regulatory compliance while securing data and systems. In addition, digital services demand is being spurred by changing consumer and citizen requirements in how they interact with and digest technology and data.

CGI’s third-quarter adjusted EBIT margin expanded 70 basis points year over year to 14.8%. The margin expansion was attributable to higher-margin business mix, infrastructure automation, and higher employee utilization. We expect the company to shift to a more asset-light business model and a continued rotation to more valuable digital services, which should lead to modest EBIT margin expansion over the midterm.