In last week’s Sector Scan column, James Samson of Lincoln Indicators shared his view that the information technology sector is ready to stage a comeback. He gave us a list of five shares to consider and from that group we have selected Hansen Technologies (HSN) for a closer look.
In a time when global share markets are teetering between the bulls and the bears, many retail investors are looking for safer investments. On several measures, HSN qualifies as a solid defensive play.
First, their business is providing billing services to the utility and telecom sectors. Common sense tells us that even should the sky fall as some bears predict, people will still need electricity and will still use their telephones.
However, companies with substantial debt do not always weather a storm, regardless of the business they are in, so we will want to look at the strength of HSN’s balance sheet. We will begin by comparing some key statistics for Hansen with another information technology company on the list, TechnologyOne (TNE). Here are three important market valuation ratios for the two shares, as well as the numbers for the IT sector:
|Price to Earnings (P/E)||11.1||15.87||11.09|
|Price to Earnings Growth (PEG)||.95||1.19||1.07|
|Price to Sales (P/S)||4.51||2.31||.86|
The intriguing number here is the PEG Ratio for HSN. When you couple that number with the relatively modest Price to Earnings ratio of 11.1 it appears HSN might be looked at as a potential GARP share (Growth at a Reasonable Price, see article on GARP by clicking here).
GARP investing is somewhat of a hybrid between Growth investing and Value Investing. The approach looks for shares with solid growth potential at a reasonable, or bargain, price. The PE ratio suggests value and the PEG ratio suggests growth.
One simple way to take the next step is to look at the earnings growth rates for the shares over time. Some retail investors might explore revenue growth as well, but the ultimate test is translating revenue into earnings, so we feel earnings growth tells as much of the story as we need to know. Here are the 10 year and 5 year growth rates for the two shares:
|% Earnings Growth 10 yr||8.3||9.8|
|% Earnings Growth 5 yr||117||11.1|
In the longer term the two show similar earnings growth but something has been going on at HSN over the last five years. To look beyond that number we take a detour to the HSN website to see what we can find out.
We learn Hansen entered the US market during the 5-year period of explosive growth with the acquisition of an American company, NirvanaSoft. Unfortunately, most of the rest of the information we can find is limited to the past two years, so we need to delve further.
The search yielded an analyst report that tells us the HSN history we need to know. When the company went public in 2000, they only dealt with the telecom sector and an astounding 60% of their business was with three customers. What is worse, 30% was from one customer, a telecom giant of the time called WorldCom. In case you did not know, WorldCom went bankrupt in 2002.
As a result, Hansen expanded into the energy and utilities sector and their current business model strives for no more than 8% in revenue from a single customer. In addition, they switched from direct selling of licenses to use their billing software to providing the license in exchange for a percentage of the customer’s total billings. In effect, they created an ongoing royalty revenue stream and locked in their customers. During the five-year period, they also expanded into the UK and Japan.
Now that we have an idea where the growth originated, we can turn our attention to the financial health of HSN. There are several complicated financial ratios we could look at, but a simpler way to begin is to look at dividends and total long-term debt. Companies do not pay dividends without a strong balance sheet. While high debt levels are not always negative, they do bear further investigation. Here is what we found for HSN and TNE:
|Dividend Yield (%)||6.0||4.8||4.8|
|Payout Ratio (%)||69||98||N/A|
|Long Term Debt ($m)||0||1.7m||N/A|
The fact HSN has no long-term debt is impressive as is their dividend yield. In addition, note their payout ratio of 69% vs. the 98% for TNE. Dividend yields draining 98% of earnings cannot be sustained over time. There may be a one-time event accounting for such a high payout from TNE, but that is a different story. What we need to look at here is the payout ratio for HSN suggests they will be able to continue paying a dividend going forward.
James Samson gave us another clue regarding HSN’s financial health we need to investigate and that is currency exchange rates. Overseas business accounts for 40% of HSN’s revenue, so the value of the Australian dollar versus foreign currencies could be a potential problem.
We look at the financial reports on the HSN website where we find in 2009 the company lost $22,000 due to currency variations. In 2010, they actually showed 94,000 in income due to exchange rates.
Investing guru Peter Lynch once noted that investors should not be buying shares looking into the rear-view mirror. Looking beyond the numbers so far verifies this company’s solid growth record in the past. What of the future?
One indication is the company’s own announcement raising its guidance for 2011 to $17 million in pre-tax profit, an increase of 20%. For the rest of the story, we need to look further.
With their relatively recent acquisition of US based NirvanaSoft, HSN has doubled its customer base in the United States and anticipates substantial revenue growth in that market. In January 2011, they announced a strategic alliance with another American company, Milestone Software Solutions. Their goal is penetrating the billing market for the anticipated explosion in the use of Smart Meter technology.
Utilities all over the world are moving to Smart Meters to improve energy efficiency and few have billing systems that can handle these new metering stgices. What’s more, Smart Meter technology is migrating beyond electrical utilities into water, natural gas, and even the telecom sector.
With the massive potential of that market and their proven performance record, Hansen’s future looks bright. In normal times, most intelligent investors would be ready to climb on board. But these are not normal times. If you know anything about the future of Smart Meters and what some call the Smart Grid, you know there is significant government involvement in the transition. With looming debt crises, delays are not beyond the realm of possibility.
Assuming the worst, how would Hansen perform? For that question, we can look to recent history – the Great Financial Crisis. Here is a five-year chart for HSN’s share price movements:
Need we say more?
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