Magic Formula Stock Review: CGI Group (GIB)
CGI Group is Canada's largest IT consulting firm, based in Montreal, and dominates the consulting market for most of the top-shelf Canadian companies. CGI's services are concentrated into three basic areas: consulting, systems integration, and business process outsourcing. The company has focused on a few well-defined industries to target their services, namely financial services, telecommunications, retail, manufacturing, and healthcare. The largest geographic contributor to revenues is Canada, although the U.S. market provides about a third of sales (CGI entered the U.S. in 2004).
Consulting and outsourcing is a huge market with a lot of nooks and crannies and an absolute tidal wave of competition. CGI Group focuses mainly on large scale systems integration and their outsourcing contracts, which puts them into direct competition with some large competitors like Accenture (ACN), IBM (IBM), Computer Sciences (CSC), and others. A durable competitive position in such a competitive and (in many cases) discretionary market is difficult to achieve. One of CGI's biggest disadvantages is a lack of presence in cheap labor geographies where outsourcing things like call centers and IT support can be done inexpensively. Less than 10% of the work force is located in these regions, putting CGI at a disadvantage against a truly global player like Accenture. And CGI's only real geographic advantage is in Canada, where established relationships favor it. Additionally, some competitors provide their own hardware solutions, which creates customer lock-in potential (and add-on profits) that CGI cannot boast.
On the growth side, CGI benefits from a secular trend towards outsourcing of IT functions, a trend that will likely continue. It makes little sense for large companies to maintain their own IT departments when much of the work is standardized around generally accepted hardware and protocols better managed by a specialized firm. CGI's growth will come mainly from expanding into new geographies, as management hopes to build the U.S. business up to the size of the Canadian side and also add sales in Europe and Asia. Historically the company has used acquisition in this effort, completing numerous deals over the past few years, and this avenue will likely be followed in the future. Recent results have been pretty good given the environment, with backlog at $11.8 billion and new contract wins exceeding revenue.
Financially, CGI has a strong position and has been steadily improving operations for several years. Cash on the balance sheet totals $271 million, vs. just over $300 million in long-term debt, and interest coverage is not a concern. Free cash flow margin has averaged around 6% over the past 5 years, about average for the industry, but has been improving over the past few years. Operating margin has marched up from about 9% in 2005 to about 11.5% today. MFI return on capital has been right around the 60% range. CGI's nominal return on capital is more pedestrian though, at about 9% when you add in acquisition costs.
CGI Group can really be summed up in two words: plain vanilla. The business is a good one but competitive, the growth prospects are available but not easily grasped, and the financial position is nothing to be concerned about or excited over. Customer satisfaction rates are good but are no substitute for the hardware lock-in that some competitors can boast. New contracts and backlog have remained steady but are not exploding. In a nutshell, CGI Group is a good company that is certainly underpriced at a 13.3% earnings yield, and will probably deliver MFI investors decent returns. MagicDiligence has a positive opinion. But it is not exciting enough to consider as a MagicDiligence Top Buy pick.