Amdocs stock: strength in the cloud and 5G, but holding after the rise (NASDAQ: DOX)

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Amdocs Limited’s software and service provider (NASDAQ:DOX) the strategy to focus on telecommunications (telecom) operators and enterprises since 2013 has been successful, with the company steadily increasing its quarterly revenue since then to $1.145 billion, as shown in the blue chart below.

Earnings numbers also rose as seen in the orange chart, encouraging investors to put their money in the stock. As a result, after the stock has gained 16% since the start of 2022, the rolling GAAP price-earnings multiple has appreciated to 19.5x.

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Data by YCharts

Therefore, for people who want to invest at this stage, the aim of this thesis is to assess whether the growth story can continue without forgetting the parameters of profitability, leverage and cash flow.

I start with the value proposition that Amdocs brings to Communication Service Providers (“CSPs”).

Meet the needs of CSPs

The company has managed to position itself in the right place to benefit from one of the telecommunications industry’s most pressing needs, which is to quickly move from a traditional data center environment to network-based operations. cloud. His approach was twofold.

Firstly, from a technological point of view, it has developed expertise around cloud microservices architecture that allows the separation of large and complex applications used by telecom operators into smaller, independent of each other and simpler components. to manage. Technologies like Kubernetes are then used to automate (orchestrate) specific functions in the BSS (Business Support Systems) and OSS (Operations Support Systems) that are used by telecommunications operators.

In the same vein, the applications are also continuously optimized, not only in terms of performance, but also taking into account the consumption of computing and storage resources, so that at the end of the month, the CSPs don’t end up paying exorbitant sums to public cloud providers (hyperscalers) like Amazon (AMZN) for its AWS.

In addition to technical performance and cost, Amdocs brings many automation features such as automatic resolution (self-healing) in case of system downtime. This helps telecom operators reduce the number of man-hours needed for troubleshooting purposes and is particularly relevant for companies that have been used to large teams running their data centers changing operations to become more agile. , thus saving on costs.

With these skills, Amdocs is trusted by major service providers like AT&T (T) and T-Mobile (TMUS) as they need to convert thousands of applications to cloud format. Amdocs has also been instrumental in modernizing its customers’ consumer domains through digital transformation. Its ability to execute quickly has helped companies get their products to market faster and beat the competition. This explains its high customer success rate as shown below.

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Presentation of the company in (seekingalpha.com)

In addition, digital transformations are essentially IT projects, which suffer from a high percentage of failure, namely 25% to 85%. That’s pretty high, and that’s why Amdocs has a consulting division that assesses how quickly customers can get cloud ready. Therefore, advising customers on how they can migrate IT workloads to the cloud is crucial to limiting unnecessary expenses. For this specific purpose, as part of its hybrid cloud management platform, the company has a FinOps (financial operations) module that focuses on the finer details of resource usage that are not normally not provided by hyperscalers.

Areas of growth, profitability and cash flow

In addition to the cloud, Amdocs is also focusing on 5G, more specifically on the monetization aspect, in particular through a five-year agreement with a European Tier 1 operator for the implementation of its policy control solution based on the cloud to support the deployment of a fifth-generation autonomous network. It also has managed service contracts with Bell Canada (BCE) and a digital transformation project with VodafoneZiggo in the Netherlands.

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Presentation of the company in (seekingalpha.com)

In contrast, the company’s gross profit margins, which are around 30% lower than the IT industry average, have hovered around the 35% mark, as shown in the chart below. This shows that the cost of revenue is higher, probably due to the investment in telecom type platforms which can be quite complex given the number of network elements involved.

Diving further into the bottom line, operating margins of 14.3% achieved in Q2-2022 are above the industry average. However, it decreased slightly compared to the previous quarter due to higher R&D investments and higher labor costs in a tight market, impacted by wage inflation pressures.

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Graphs built by the author using data from (seekingalpha.com)

Going forward, according to executives, the company’s focus on operational excellence through the use of automation tools should gradually increase efficiency and offset the rising costs of doing business.

Operating expenses now include general and administrative (sales and administration) expenses, and these increased 15.4% to $135 million in the latest reported quarter. Thus, the business has to spend relatively more to boost sales and grow organically. This involves strong competition and in response, Amdocs has also opted for inorganic growth through mergers and acquisitions.

Evaluations and key points

In this regard, its agreement to acquire Mycom OSI, a carrier service assurance software provider, for approximately $188 million is expected to further boost sales prospects, especially for 5G and enterprise assurance. . This is to ensure high reliability and performance during mobile network deployments. Mycom also offers a range of AI-based operational solutions for NOCs (Network Operating Centers) with some big names in the industry like Vodafone (VOD) being part of its customer portfolio.

However, with capital expenditures averaging $54 million over the past four quarters and the cash acquisition of Mycom at $188 million, free cash flow (“FCF”) is likely to be affected. Already, the cash margin, which is FCF divided by revenue, has fallen below 10%, as shown in the chart above. Additionally, debt of $880.6 million at the end of March is slightly higher than the $856.4 million in cash and cash equivalents.

Turning to a positive note, the company recorded growth of 9.2% on an annual basis in the third quarter, which is well above what it has achieved in the last three years. With the recent acquisition, it is expected to grow faster, but, in this regard, Mycom sales are expected to add less than 1% to the combined entity’s revenue and only from fiscal 2023.

In the meantime, the company is expected to execute on its growth strategy, helped by a record backlog of $3.89 billion, up 10% from the same period of 2021. , expectations are for full-year 2022 diluted EPS (on a -GAAP and pro forma basis) to beat the $4.81 achieved in 2021 by 9% to 12%.

Therefore, balancing growth, profitability, cash with debt, and after accounting for an increase of more than 12% since May 11, I consider Amdocs to be more on hold at this time. SA’s Quant ratings also indicate that they are holding, as shown in the figure below.

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Quantitative assessments (seekingalpha.com)

Continuing further, as a software provider for telcos and other large enterprises, Amdocs also pays dividends at a yield of 1.82%, and with a payout ratio of 28%, the company has the ability to pay more. This ability will ultimately depend on its ability to generate more cash flow from operations through project milestones being delivered more quickly to customers, as well as unlocking more of the deferred revenue currently locked in accounts receivable.

Finally, for those looking to invest in the stock, it is important to look for an improvement in the FCF when the third quarter results are announced in the first week of August, since high inflation can quickly erode the real value of stocks. cash.

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