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Princely profit margins give CGI an investment edge Add to ...

CGI Group Inc., the Montreal-based information technology and outsourcing firm, should be a screaming buy.

The company reported another sterling profit figure on Thursday, with share earnings for the quarter soaring 50 per cent from the same period last year. Over the past 12 months, CGI has generated $1.95 a share in cash from operating activities, excellent for a stock that only recently sailed past the $20 mark.

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Yet the investment community is divided. Of the analysts who follow it, 10 call it a "buy," while seven call it a "hold," according to Bloomberg.

The investment story on CGI: If you think the economic upturn still has legs, the stock is a great place to park some money, although it does have issues that may cap its upside. For more cautious types, the stock, which as recently as late September traded for under $15, might be a bit ahead of itself, especially if its stellar profit gains show any sign of pausing.

The table-pounding bull on the Street for CGI is Kris Thompson, National Bank's tech analyst, who has a price target of $26 a share, but thinks the company may do substantially better in the right economic scenario.

Mr. Thompson, who liked the company before the second-quarter report, said the results have made him even "more positive. Cash flow was massive - a record."

His optimistic case for the CGI is built on the company's profit margins, which are higher than those of industry leader Accenture PLC.

CGI maintains high margins by eschewing aggressive price cutting on contracts, and is willing to let customers walk if they press too hard for deals. This presents a risk to earnings if competitors poach too many customers, but maintains high profits if clients believe the service is good enough to stick around.

"CGI is doing a fantastic job at executing operating margin growth. My view is they're not getting rewarded for it," Mr. Thompson said.

Cash Flow

Another impressive feature of CGI is how it is using its cash flow. It has one of the most aggressive share buyback programs ever seen in Canada. Since 2005, it's bought back approximately 39 per cent of its stock, at average prices of about half the shares' current market level. The upside for remaining owners is that profits are then divided among fewer shares, a big plus.

Corporate spending on information technology (IT) is on the upswing, thanks to the recovery from the 2008 financial panic. Mr. Thompson says that over the next six to eight quarters, CGI shares might even trade through $30, given continued economic growth.

Possibly the biggest drawback with CGI is its ownership structure, loaded up with those dual-voting stocks that most investors hate because they entrench insiders with relatively small stakes.

CGI founder Serge Godin controls 50.1 per cent of the votes through multiple voting stock. If these shares carried regular voting rights, Mr. Godin's actual equity interest would be a puny 11 per cent.

This structure means shareholders won't benefit from the wave of lucrative consolidation that is rolling through the IT outsourcing space unless Mr. Godin approves. Analysts say he has no intention of selling out any time soon.

Takeovers can be rewarding. Earlier this month, a U.S. competitor, SRA International, was taken private at a premium of 53 per cent over prices prevailing before it became subject to acquisition speculation.

The cautious take on CGI is that the company's prospects are almost fully reflected in the shares. CGI doesn't pay a dividend, so investors have to be confident its share price will rally enough to make a purchase worthwhile.

Maher Yaghi, at Desjardins Securities, has a target of $22 a share, not much above the current price, reflecting his view on the company's limited upside. He was bullish last year when the shares traded around $15, and was happy to take profits this year at around $20.

 
Security Price Change
GIB.A-T CGI Group 37.50 -0.49
-1.29 %
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