We believe that market sentiment towards Kainos (KNOS) is on the cusp of a reversal, and that creates a buying opportunity for investors. Shares in the Belfast-based digital services expert are now trading at a 30% discount to 12-month highs and are barely half all-time peaks of more than £20.
This is largely because of what analysts have called a cyclical slowing of corporate digital services growth, possibly a function of decision-making delays as management teams grapple with their own AI (artificial intelligence) strategies. We believe this could be about to turn.
PROMISING BACKCLOTH
Technology has been transforming how organisations operate for decades but the pace of change has never been faster, and now AI is powering the next growth leap forward.
According to PwC, AI will contribute approximately $15.7 trillion to the global economy by 2030. Experts uniformly say the idea of AI disruption is very real, and that there is huge scope to improve things in the business world, whether it’s around making individuals more productive, improving decision making, driving down costs or creating innovative end user experiences and interactions.
Because there is no one-size fits all AI adoption pack, with each use case requiring tuned, domain-specific models trained with quality, proprietary data, we and analysts believe there is a fundamental opportunity for Kainos in the years ahead.
Recent commentary has also been supportive of a slowly changing demand dynamic, with the likes of IBM (IBM:NYSE) and Cap Gemini (CAPP:EPA) reporting fuller order pipelines as clients shift from experimentation to deployment. Next week (20 May), Kainos will report full year 2024 results (to 31 March) and we anticipate the tone to be one of carefully managed optimism, but it could trigger a swathe of bargain buying given the relatively lowly valuation.
WHAT DOES KAINOS DO?
Kainos is a FTSE 250 IT business that does two things. Digital Services helps (typically large) organisations transition their processes and operations into the 21st Century digital world, including as a key supplier to UK government departments, often writing bespoke tools and software.
Then there’s its Workday (WDAY:NASDAQ) practice, its partnership with the $65 billion US enterprise human resources and financial planning software platform, providing clients testing, training, installation and audit for the platform, plus designing new products to enhance the Workday platform.
The Workday practice has powered much of the growth in recent years and revenues are now worth almost half of Kainos total, seen at £392 million, according to Stockopedia 2024 consensus data. Consensus for 2025 has come down in recent months to the current £424 million revenue and £63.3 million net profit, again based on Stockopedia data.
WHAT’S THE PITCH?
Yes, growth has slowed, but there is strong scope to accelerate again through the rest of this year and beyond. ‘Our confidence is reinforced by our long-term customer relationships, and the calibre of our people, who continue to excel in delivering high-impact solutions for our customers,’ said chief executive Russell Sloan in an update in April.
‘In the near-term, an increased backlog, a robust pipeline and a strong balance sheet provide excellent visibility of the strength of our performance in the current financial year’, Sloan added.
Sloan may have only been in the top job since September 2023, but like predecessor Brian Mooney, he has been at Kainos man and boy, joining out of Queen’s University Belfast in 1999.
True, digital services demand could remain soggy for longer than optimists anticipate, while slower than expected Workday growth could drag on sentiment. This latter option looks unlikely, with analysts at Megabuyte in April pointing out ‘sales records’ for new product lines.
As investors have latched on to the short-term negatives, it has left the shares trading at valuations not seen in years. The implied 2025 PE (price to earnings) multiple is barely 20, versus a five-year average PE closer to 40.
Yet throughout this recent slower spell, the company has maintained exceptional returns metrics. Data from Stockopedia shows returns on capital and equity of 38.7% and 32.9% respectively, with operating margins running at 14%, scoring the company a Stockopedia ‘quality’ score of 96 out of 100.
The share price might not suddenly surge 20% or 30% but the opportunity for an incremental re-valuation higher remains strong, as do the underlying fundamentals of this, in our opinion, excellent business. We think time will show this is a great buying opportunity.
These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell.
Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.
Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
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