a morning spent at the dtl a.g.m, page-7

Alnby, thanks for generously sharing your file notes with us.

While I didn’t attend the AGM in person this year, I did study the transcript with interest.
Judging from some of the subsequent comments posted here, as well as some points that are worth making, I feel the following are the salient investment considerations that investors need to understand clearly when it comes to DTL:

1. IT Industry change/flux/evolution/transition (whatever one wants to call it)

2. Earnings, especially the implications of the one-third/two-thirds split in Profit Before Tax between 1H,FY13 and 2H, FY13.

3. Capital management, notably in relation to dividends and share buyback over the next 12 months

4. Valuation (the most important factor)


So let’s deal with each of these:


1. IT INDUSTRY CHANGES

On this point, Wang Chung, I’m afraid I didn’t quite understand your post “Always changes going on. Nature of the IT industry. But to directly answer your question, not the slightest bit concerned”.

I couldn’t figure out to whose question you were directing your answer, but I assume you are/were referring to the dynamic IT landscape, with the advent of cloud computing and the like.

Suffice to say that I agree with you that this what it is, and that DTL will continue to flourish irrespective of the prevailing technology at any given point in time.

In fact, not only that, but I will go a step further and happily argue, supported by history and precedent, that it is in fact the continuous changes and advances in systems technology that keeps DTL in business, given that it is a highly credentialised vendor of such technology hardware and software.

Put another way, the inevitable and never-ending upgrade cycle that is part of the information systems of corporations (public and private alike) is the reason for DTL’s profitability. As long as technology changes, which is an axiom, enterprise and government are forever forced to adopt the changes.

Of course there will be periods of hiatus, such as the present and the past 12 months, when an ebb business confidence means that companies have generally paused their investment in IT upgrades, but as sure as night follows day, the process will resume at some stage over the foreseeable future. It always does.


2. EARNINGS GUIDANCE

Something that I think deserves some qualifying comments is management’s guidance that DH13 Profit Before Tax will make up just one-third of the budgeted full-year number.
Also, reference is made to full-year FY14 Profit Before Tax budgeted to come in close to FY12’s figure.

For context, recall that FY12’s figure for Profit Before Tax was $17.5m.

From this guidance, we can calculate the expected 1H:2H Profit Before Tax in dollar terms (not, in the interests of conservativeness, I have assumed a Profit Before Tax figure of $17.0m):

So, Profit Before Tax is expected to be:

DH13 = $5.7m (33%)
JH14 = $11.3m (67%)

Now, arising from this, a few points are worth noting:

Firstly, $5.7m is a poor number. It works out to more than a 40% fall in the level achieved in the pcp. One has to go back to DH07 to match $5.7m in Profit Before Tax.

Second – and this is the more striking fact – the $11.3m figure implied as an expectation for the second half would basically be a near-record achievement, surpassed only once, namely in DH2010, as we emerged from the depths of the GFC.

Note that the implied second-half guidance reflects growth of 48% on pcp. By comparison, that DH2010 number worked out to be over 70% growth on pcp.

So while there is a lot baked into management’s 2H,2014 guidance, it is not unachievable, especially when one considers that there will have been significant investment deferrals by corporations – and indeed by the Federal government, too – in the period leading up to the Federal election. So John Grant’s observations, as relayed by Alnby, about “significant things now visible in the pipeline that they were working toward” appear to be quite plausible.


3. CAPITAL MANAGEMENT

I think all the speculation as to whether the absence of a share buyback provides any signal about the over- or under-valuation of the company is not very fruitful.

I say this for a few reasons:

First, DTL is a notoriously illiquid stock. The last thing that is needed is for what little liquidity there is, to be mopped up by management in a buyback and then cancelled. It might make perfect sense in a valuation theory sense, but it is not likely to be very helpful in a practical sense.

Secondly, I think the balance sheet is utilised more than people might think. Due to the quirks surrounding the differing timing of payments in June halves compared to December halves, it is not uncommon for working capital swings of $60m, $60m and even more half-on-half.

So DTL utilises its balance sheet quite aggressively to secure business. It is therefore not that desirable to take on much financial leverage, I suspect the board believes (and being somewhat of a fiscal conservative, I agree wholeheartedly).

Finally, I’m certain John Grant is a consummate IT executive, but I’m not sure he’s that well trained as an investment practitioner, or has any insights into where share prices are heading. So I’m not sure “defending” the share price is his brief, and I’m sure the board doesn’t see it as such either.

As for the all-important dividend, based on the $17-odd Profit Before Tax guidance, that works out to EPS of roughly to 7.80 cps, but split 2.60cps in DH13 and 5.20cps in JH14.

So the board could still for FY14 maintain the 7.0cps dividend declared for FY13, as it would correspond to a 90% payout ratio (The payout ratio for FY13 was 89%).

However, the DPS split in FY14 might be a bit different to FY13, which was 1H = 3.45cps and 2H = 3.55cps. But the company’s franking credit balance of $17.6m (11.4cps) means that the board could certainly declare DPS for 1H14 well in excess of expected EPS of 2.60cps without having to worry about the ability to frank the dividend.


4. VALUATION

The most important thing to get head around when valuing DTL is the considerable cash movements half-on-half, as discussed earlier. The company has negligible debt (<$2m) and the cash balance is usually a small, single digit value at the December balance date, and ends up being a large multi tens of millions of dollars at the June balance date as government departments and corporate customers rush to make pre-payments before budgets expire at the end of the financial year.

To wit, Net Cash position at the following balance dates show the seasonality:

June 2005: $9.2m
Dec 2005: $5.6m
June 2006: $14.0m
Dec 2006: $2.9m
June 2007: $17.4m
Dec 2007: $7.0m
June 2008: $17.0m
Dec 2008: $8.8m
June 2009: $28.0m
Dec 2009: $1.3m
June 2010: $64.3m
Dec 2010: $0.8m
June 2011: $53.9m
Dec 2011: $9.2m
June 2012: $68.3m
Dec 2012: $1.5m
June 2013: $83.5m


Therefore, when estimating an Enterprise Value, I tend to take an average Net Cash figure for any given financial year, so notionally $40m.

Adjusting the market cap of $166m by this cash number, yields an EV of around $125m which works out to around 6x EV/EBITDA.

For a company whose ROE has averaged over 40% over its history (and even during a major slump in its business environment, as it is currently, the ROE is still “only” 25%), 6x EV/EBITDA is a very undemanding valuation.

Put another way, the $40m in net cash equates to 25cps. Adjusting the 108c share price for this, and dividing the result by this year’s “bottom-of-the-cycle” EPS of 7.8cps, yields a P/E multiple of just 10.6x.

Once again, not an extreme valuation metric at all, given we are capitalising a severely troughed earnings base.

Finally, in a yield-beset world, a 6.5% Dividend Yield, which looks eminently sustainable suggests to me that the downside is limited.


Accordingly, I am happy to declare that I bought some stock after the AGM last week.


Cam