Accentuate the Negative
Consolation for IT consulting firm Accenture.
Aside from distancing itself from scandals, much of the success of Accenture was due to the fact that it had latched onto the high growth, high margin business of providing information technology services to global corporations to help them become more efficient. This is similar to the strategy IBM (NYSE:IBM) used to transform itself from a hardware maker into a service provider. But just as IBM’s last earnings report on October 17 caused its shares to tumbled some 10%, citing weakness in IT spending, it seems that the industry is not only in a soft patch but may have passed through the sweet spot of accelerating revenue and profit gains.
Over the past decade, most corporate clients have made great gains in using technology to achieve production efficiency. The major shifts towards cloud computing, integration of real-time data sharing, and cutting expenses (for example, by reducing head count) have mostly been made. Companies now operate mean and lean, which means that the expense of bringing in a third party for further system overhauls has a diminishing return on investment.
The slowdown in growth has been exacerbated by the various global crisis, and IT spending has become a major casualty of cost cutting. Accenture generates some 25% of revenues and profits from Europe; that is expected to decline by 9% in 2013. Emerging markets offer little offset as countries such as India, Brazil, and China have tamped down growth expectations and are dealing with their own political and fiscal uncertainties. This has taken a toll on profit margins, which contracted 78 basis points year-over-year to 9.16% during their fourth quarter. Earnings are expected to decline by 6.5% to $0.97 per share next quarter. [ACN earnings are expected to come out December 19. A spokesperson for the company said they are estimating earnings would rise by 4%.] Considering the fact that the fourth quarter is traditionally seasonally strong for IT spending as departments take a “use it or lose it” attitude towards budgets, this decline in estimates is especially worrisome.
More to Lose
Right now, the stock is trading around $69. It is in the middle of its recent range between $64 and $72 of the past two months, and the chart gives little clues. My guess is that it will remain range-bound until its December 19 earnings announcement, which I think will be a big disappointment. This gives us a little time to wait for an attractive entry point. If shares trade up to the $70 level in the future, I would look to buy the $65 puts in either December (which will expire three days after the earnings report, giving you plenty of bang for the buck) or for a longer term bearish play, use January puts (which will be less impacted by the time decay and decline in implied volatility that follows an earnings report).Using IBM as the analog should work, as a 10% single decline would pop the January options. IBM shares, which initially dropped another 5% six weeks after after its disastrous earnings report, have had very little recovery and are still trading at post earnings report levels.
I see Accenture trading down to the $60 level support level within the next two months and I’ll be looking to buy put options to provide a consolation prize in what might be part of a broader bear market.
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