EUR 850.00 For Business Accounts Only

Morningstar | DXC Reports Solid 1Q; USPS Departs while Margins Improve Nicely; Shares Fairly Valued. See Updated Analyst Note from 07 Aug 2018

Reading between all the moving pieces, DXC reported solid first-quarter results as the firm remains on-track to deliver on its fiscal 2019 guidance. From a reporting standpoint, the firm's results remain scrappy due to the infancy of DXC and the recent separation of its U.S. Public Sector, or USPS, business into the publicly traded firm Perspecta. Despite the clutter surrounding reported results, proforma results, restructuring costs, separation and integration-related costs, amortization of acquired intangibles, and tax adjustments, among others, the firm's underlying adjusted EBIT margin performance was above our estimate at 15.2%. On a GAAP basis, the firm also managed to eke out year-over-year revenue growth (excluding the USPS business). We continue to think management will benefit from the separation of USPS as they will be able to turn their full attention to the typically higher growth commercial sector. There is still a lot of progress to be made before DXC rivals the top IT services players, but the scale of the business and existing relationships should stand this narrow moat company in reasonable shape over the midterm despite intense competition. After the quarter, we are assuming better midterm margin performance from DXC as it focuses solely on the commercial space and continues to reap cost synergies from the combination of CSC with HPE's Enterprise Services business.

As a result, we are modestly raising our fair value estimate to $93 per share from $88. Still, with shares trading near our fair value, we'd seek a wider margin of safety before investing in the name.

For the quarter, GAAP revenue (excluding USPS) grew 0.9% year over year to $5.28 billion (fell 1.8% in constant currency). Global Business Services, or GBS, saw clients move away from traditional application services to modernized enterprise application services and business process services, much like the prior quarter. Global Infrastructure Services, or GIS, continued to see client migration to hybrid infrastructure environments as a primary growth driver. Positively, digital revenue saw a book/bill ratio of 1.6:1 and grew 21% from the prior year. Digital transformation work will have to be the crux of DXC's growth engine over the long term, but the business remains small and is still being outweighed by declining legacy services lines. We will continue to monitor DXC’s ongoing digital initiatives to determine the firm's long-term success in the IT services industry.

On the margin front, DXC's adjusted EBIT margin improved to 15.2% from 10.9% in the year ago period. Margins expanded notably across both GBS and GIS due to ongoing cost saving actions across the firm and the utilization of process automation. We expect the company to remain committed to margin expansion and see efforts associated with the firm's workforce, supply chain, policies, and facilities as areas of continued focus.