EUR 850.00 For Business Accounts Only

Morningstar | DXC Reports Mixed Results; Revenue Miss Raises Some Concerns; Shares at a Discount

DXC reported a decidedly mixed second-quarter result with revenue weaker than expected but adjusted EBIT margins stronger than expected. We’ve always been more confident in DXC’s ability to execute on its margin expansion story given the cost-cutting and operating leverage available to management due to CSC and HPE Enterprise Services combining to make DXC. However, our thesis has been more concerned about top-line growth volatility. Such volatility was rumored by news outlets on Oct. 24 and evidenced in the firm’s published results. In fact, second-quarter revenue was about $200 million below management’s expectations with a slower ramp-up in large digital contracts and a decline in application maintenance and management being the key weak spots. As a result, the company lowered its full-year revenue outlook from the range of $21.5 billion-$22.0 billion to $20.7 billion-$21.2 billion but raised its EPS forecast from $7.75-$8.15 to $7.95-$8.20. After adjusting our model to account for the updated outlook, we are slightly lowering our fair value estimate to $91 per share from $93. With shares trading in 4-star territory, we think DXC would appeal to investors with a high appetite for risk who are looking for broad exposure to the IT services market.

With the stock selling off significantly over the past couple of weeks, we believe that management needs to address management turnover and revenue growth concerns. To allay investor fear, DXC’s CEO, Mike Lawrie, noted that they are working to refocus their salesforce within the application business and pushing to attract the necessary human capital to fulfill a healthy digital services pipeline. Still, this will take time to remedy and with the digital position of the firm remaining anything but guaranteed in today’s highly competitive IT services environment, we think the company’s no-moat rating is highly appropriate.

For the quarter, reported revenue fell 8.1% year over year to $5.01 billion (declined 6.2% in constant currency). Notably, digital revenue was up only 6.4% year over year (we would expect this to be in the range of 20%-30% given peer comparisons), which reflected a mixture of DXC execution issues and a delay/elongation of clients scaling their digital projects. While client specific issues are less of a concern, we believe DXC needs to do better at bringing on the right resources to fulfil the digital demand they are seeing. Management did note that they are accelerating digital hiring through a digital hiring engine, but we will continue to view this hiring process with a lukewarm response until we start to see digital sales on par with the overall industry’s growth rate.

On the margin front, DXC’s adjusted EBIT margin improved 230 basis points year over year to 15.9%. The strong margin improvement continues to illustrate the good job management has done as they focus on workforce, supply chain, policy, and facility rationalization and efficiency. We continue to expect margin expansion over the midterm too as these same cost-saving pillars remain leveragable.