The Investment Column: Sema's rating is hard to justify
Wednesday 25 February 1998
The shares, which have risen by 43 per cent since the beginning of December, now trade on a multiple of 41 times the forecast for this year's earnings by broker Credit Suisse First Boston. Sema is growing quickly, but is it expanding fast enough to justify that kind of rating?
Pierre Bonelli, Sema's chief executive, would like you to think so. He points to the company's swelling order book - bolstered just last week by a five-year pounds 305m deal to take over the running of the Benefits Agency's medical services division. Then there's the contribution from recent acquisitions, which chipped in operating profits of pounds 4.5m on sales of pounds 75.6m. Mr Bonelli also thinks there's room to improve profit margins from their current levels.
Finally, there's the potential to expand in the US - a move that was ruled out until the middle of last year because US regulators deemed Sema to be a subsidiary of Paribas, the French bank which is one of its major shareholders.
That said, there are plenty of reasons to be sceptical. For one, Sema's underlying growth rate is not as marvellous as the headline figures suggest. Strip out currencies and acquisitions, and turnover was up 14 per cent last year - creditable, no doubt, but not spectacular in this booming industry. Admiral, Sema's smaller rival, yesterday reported a 29 per cent increase in turnover, with no contribution from acquisitions at all.
On margins, too, Sema falls short. Admiral's operating margins increased to 14.5 per cent last year. Sema's edged up to just 6 per cent. Although the company is aiming to increase its return on sales, higher R&D spending on its software products will also push up costs.
Then there is the US. Sema clearly needs an acquisition, but seems confused about what to aim for. Mr Bonelli reckons there are several options: buy a series of smaller product companies, splash out up to $1bn (pounds 610m) on a Sema lookalike, spend a similar amount on a company specialising in, say, telecoms, or get into the market through outsourcing contracts. All that's clear is that Sema still has to make up its mind.
In the meantime, Sema will have to keep on hiring staff. The company needs to take on 1,000 workers this year to handle all the work, and will need another 1,000 to replace the ones who leave for jobs elsewhere. Mr Bonelli doesn't seem to think this is a problem. But as rival Logica found to its cost last year, the market is unforgiving about slips in this particular area.
Let's be clear: Sema is a quality company. It's well managed, its track record is admirable, it's in a fast-growing industry, and the opportunities for future growth are mouth-watering. But lemming-like buying by British fund managers in recent months means that its share price valuation is now completely out of kilter with any reasonable assessment of its prospects.
Given the real possibility of skills shortages restraining growth or of Sema overpaying for an acquisition in the US, all the risk is on the downside. Sell.
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