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Morningstar | DXC Holds Investor Day; Outlines Goals Into Fiscal 2022; Beaten-Up Stock Trading at a Discount

DXC hosted its 2018 investor day and, after a tumultuous couple of weeks for the stock, it was a time for the company to assuage investor fears over the company's managerial rifts and growth trajectory. After accounting for the investor day, we are reiterating our $91 fair value estimate and economic moat rating of none. With shares trading at an approximate 30% discount to our $91 fair value estimate (current price implies a fiscal 2019 price/adjusted earnings multiple of 8.3 times), we think shares are attractive and would appeal to investors with a high appetite for risk who are looking for broad exposure to the IT services market.

From a managerial standpoint, CEO Mike Lawrie was very candid about recent turnover in the upper ranks, saying that he hasn't ousted anybody who didn't deserve it and that recent turnover was due to those individuals not buying into the company's long-term vision or Lawrie's pragmatic style of leadership. While the turnover is unsettling, we don't view it as an inherent structural weakness in the business. We will continue to monitor the situation, though, as the firm eyes ongoing workforce optimization among its multiple margin expansion levers.

With DXC about one year behind its originally planned revenue growth aspirations, we think that the firm needs to demonstrate positive top-line growth to get investors comfortable with the future of the company again. Management broke down its growth and noted that the legacy, or core, part of the business was declining as expected, but the industry intellectual property and brand protection systems business and digital business were not growing as hoped when outlined at investor day 2017. Industry IP and BPS growth has been stagnant (hoped for 7%-10% year-over-year growth) and the digital business is only growing in the midteens (hoped for 25%-30% year over year).

With DXC looking to fiscal 2022 at investor day 2018, the firm stated that it now sees the industry IP and BPS business growing at a 4%-6% CAGR and the digital business growing at a 20%-30% CAGR, which represents a downward revision for the industry IP and BPS business and a wider range for the digital business. We continue to see growth volatility as a key risk for the firm and take a conservative stance around this metric. We expect top-line growth to be at the lower end of management's spectrum at 2% year over year over the midterm and we'll wait for the firm to prove that it can reach beyond this expectation before making any changes to this assumption.

We have less concern about the margin expansion goals and we continue to see ample room for the firm to improve its margin profile through revenue mix, workforce optimization, supply chain efficiencies, and facility rationalization, which will support solid yearly EPS growth. Still, we need to see an improvement in the firm's revenue trajectory. We do see some positives for DXC though, with about 80% growth in its digital services pipeline and a concerted effort by management to efficiently staff these digital projects after some early growing pains. Additionally, DXC's customer intimacy and scale should not be discounted. With around 6,000 client relationships, the company has privileged access to a wealth of potentially sticky customers where the firm is looking to integrate valuable high-growth digital services.