Ticker: ITE
Stock exchange: Oslo
Price: 11,50 NOK
Fair value estimate: 19,00 NOK
Recommendation: Buy
First a few words about valuation methods. I employ intrinsic valuation rather than relative valuation, meaning I do not use EBITDA multiples to determine an exit value, often referred to as a price target by Norwegian brokerage firms. Instead, I provide the stock's fair value based on the narrative I present and the discount rate I apply. While this approach might seem unconventional, it aligns with the methods endorsed by renowned investors like Warren Buffet and experts such as Aswath Damodoran, a respected professor in the field of valuation. Alas, here you get fair value estimates and not price targets. This is the first part of why this is called disruptive analytics. The second part is that it is free.
Bullish Macro Story
To put it in simple terms, the economy consists of four parts: production, consumption, income, and labor. All of these parts will go through cycles in the next 10 years, when all of these parts are deemed as weak, we have what economists call a recession. While it's challenging to predict the specifics of these cycles, I believe that the labor aspect of the economy will likely face a structural shortage throughout the current decade, particularly when it comes to recruiting skilled knowledge workers.
My view aligns with hard facts which state that the workforce will sink across the entire OECD area in the coming years, while the number of retirees will grow substantially. We can see the effects of these facts playing itself out already today in the macro numbers being reported. Thus, although, the economy has cooled substantially, there are still 2 job openings for every unemployed in the US. Businesses are struggling to find qualified applicants, a trend I anticipate will persist.
The only way to get out of this shortage is for businesses to invent itself out of it. One has to do more with less or work smarter to get the same or better results, Fortunately, emerging technologies like Artificial Intelligence (AI) provide a means to enhance productivity and output. Recent macroeconomic data indicates a noticeable increase in productivity, a fact, that also can be exhibited in the current profit margins being reported from publicly traded companies
Again, to boil it down in simple terms, you can say that the Internet solved the shortage problem during the 1990s, then the peace dividend from the fall of communism and consequently, the massive job immigration from the East solved the same problem at the beginning of this century, and now, we have AI to address the redacted numbers of qualified workers. In the 1990s, increased productivity led to “inflationless growth”, I think the AI revolution can produce much of the same results today
The macroeconomic backdrop favors Itera
”We are going to ride the AI wave”. Not my words, but the words of Itera’s CEO, Arne Mjøs, at the second quarterly report of 2023. Itera stands to gain from the AI revolution in two ways.
Firstly, as businesses seek assistance in implementing AI solutions for enhanced productivity, Itera is poised to expand its clientele and boost revenue. Clients are increasingly relying on AI and overall digital solutions to work smarter and more efficiently, necessitating expert guidance in the implementation process.
Secondly, Itera's consultants stand to benefit from the widespread adoption of AI co-pilots, streamlining tasks such as programming and debugging. This increased efficiency enables various IT consultancy teams to deliver services more effectively, meeting the evolving needs of clients.
Additionally, both Itera and its customers will gain from the development of new software applications driven by AI and machine learning models. These applications have the potential to automate numerous tasks, leading to improved operational efficiency for businesses.
Furthermore, the rise of AI technology is reshaping the consultancy landscape. Roles like "testing Ninjas," once popular among consultants, are likely to be replaced by AI solutions capable of solving discrete mathematical problems more swiftly and accurately than humans.
In summary, the intersection of growing customer demand and Itera's enhanced service delivery positions the company for a promising future. In the third quarterly report, Arne Mjøs focused on increasing operating margins in the coming years. It seems to me that Mjøs will get some macro tailwinds working for him.
Profits, profits, and profits
Above all, Itera’s management emphasized increasing operating margins in their presentation of the third quarterly report. Here is the program they will implement to achieve it:
Increase prices: pushing up hourly rates in line with inflation and increasing consultancy utilization.
Increase sales across the board: focusing on customer contact, client needs, and increasing demand-generation activities.
Reduce unnecessary overhead: transforming overheads into billable value creation.
Reduce operating expenses and curb discretionary spending.
Take a new stance regarding recruitment targets: working smarter with fewer consultants.
Itera is already seeing results from this program. EBIT margin was a bit better in Q3 than in Q2 concerning YoY comparisons.
Valuation
Itera's strategic efforts aimed at achieving higher profitability, combined with what I perceive as a favorable macroeconomic backdrop, form the basis of my optimistic outlook. I have made slight adjustments to sales and EBIT projections for 2023 and 2024, taking the current soft patch into account within the Discounted Cash Flow (DCF) model. Anticipating a resurgence in demand for IT consultancy services in the second half of 2024, I project robust growth between 2025 and 2028, with an anticipated top-line growth rate of nearly 20%. Furthermore, I expect a moderate increase in operating profit margins in the coming years. Towards the latter part of the 10-year period, I anticipate growth plateauing and margins reverting to the mean, as you can study in detail in the matrix below.
It's important to note that I have maintained the rest of the DCF model parameters, including tax rates, depreciation & amortization, and other line item ratios to revenue and EBIT. The only adjustment made is an increase in the discount rate by 50 basis points, reflecting rising interest rates and reduced liquidity in the financial system, leading to higher financial costs. Please confirm with the previous blog post for more information Itera Q2.
Please note that I have not periodized my DCF model. My experience is that this exercise doesn’t change fair value estimates to a substantial degree. We only have to accept that nine months of financial results already is on the record. In any case, financial modeling serves only as an indicator of fair value, offering guidance rather than definitive answers.
Final thoughts
Itera trades with a free cash flow yield of circa 8 % and sports a dividend yield of circa 6 %. Take notice of the fact that even though Itera is experiencing a soft patch in demand and utilization, I expect it to increase both free cash flow and dividend yield the next year. The share looks cheap to me.
Disclaimer: Important Information for Retail Investors
The information provided in this blog is intended for educational and informational purposes only and should not be construed as financial advice or a recommendation to buy, sell, or hold any securities. Investing in individual stocks involves inherent risks, and past performance is not indicative of future results. Before making any investment decisions, it is crucial to conduct thorough research and consider seeking advice from qualified financial professionals.
The author of this blog is a retail investor and not a licensed financial advisor or registered investment professional. While the author strives to present accurate and up-to-date information, there is no guarantee that the content provided is accurate, complete, or current. Market conditions can change rapidly, and stock prices can be volatile.
All investments carry a degree of risk, including the potential loss of principal. Retail investors should carefully assess their risk tolerance and investment goals before making any investment decisions. Diversification is a key strategy to manage risk, and investing solely in individual stocks may expose investors to higher levels of risk compared to a diversified portfolio.
The author may have positions in the stocks mentioned in the blog. These positions may change at any time, and the author is under no obligation to update readers on such changes. It is recommended that readers do their own due diligence and consider seeking advice from qualified professionals before acting on any information presented in this blog.
Investors should be aware of the inherent limitations of the information available on the internet, including the potential for misinformation and bias. Always verify information from credible sources and cross-reference any data presented in this blog.
In accordance with prudent compliance, the author encourages readers to carefully review and understand the prospectuses, annual reports, financial statements, and other relevant information before making investment decisions. Retail investors should be aware of their own financial situation and consult with appropriate professionals to ensure that their investment choices align with their individual circumstances and goals.
By accessing and using this blog, readers acknowledge and agree that they are responsible for their own investment decisions and any outcomes that may result. The author and any related parties are not liable for any losses, damages, or actions arising from the use of the information provided in this blog.
In conclusion, investing in individual stocks carries risks that may not be suitable for all investors. Retail investors are advised to exercise caution, conduct thorough research, and consider seeking guidance from qualified financial professionals to make informed investment decisions.