Computer Sciences has the ‘IT’ Factor
Computer Sciences Corporation [[CSC]] is among the world leaders in the information technology (IT) and professional services industry. CSC offers an array of services to clients in both the commercial and government markets. CSC’s offerings include IT and business process outsourcing as well as professional services. Outsourcing involves operating all or a portion of a customer’s technology infrastructure. IT and professional services include systems integration, consulting and other professional services. Consulting and professional services includes advising clients on the acquisition and utilization of IT as well as business strategies, security, modeling, simulation, engineering, operations, change management and business process reengineering.
Despite the dire economic climate of 2008 through the present, Computer Sciences has continued to post record earnings per share. Fiscal 2010 [ends Mar. 31, 2010] is expected to come in at $5.00 /share – up 22.8% from FY 2009’s $4.07.
Here are CSC’s per share numbers from continuing operations as reported by Value Line:
|* FY 2010 data
includes Value Line’s Q4 estimates
Computer Science has a ‘sticky’ client base with about 80% of its business derived from existing clients that would have a tough time changing providers. Their high percentage of government work ensures they won’t run into receivables problems. The federal government’s heavier use of outsourcing bodes well for future expansion.
What jumps out from the data chart above is the fact that as revenues, cash flow, earnings and book value have been growing – the stock price valuation has contracted to an extremely low multiple.
Zacks sees year ahead EPS of $5.22 making the forward P/E < 10x and the price/book value barely over 1.1x. Typically CSC shares have traded for at least 14x earnings and with a P/BV ratio of 1.5x – 2x. In the heady market environment of 1995 – 2000 CSC commanded multiples of 25 – 30 and peaked at over 5x book value.
Their balance sheet is in good shape with more than $2 billion in treasury cash and total interest coverage of about 4.6x. Value Line rates their financial strength as ‘A’ while Standard and Poors gives CSC a ‘B+’ quality ranking and their highest, 5-Star rating. Value Line notes other positives with CSC’s ‘stock price stability’ and ‘earnings predictability’ at the 85th and 100th percentiles respectively (with 100th being best).
It doesn’t seem too aggressive to expect a rebound to at least 13x projected earnings over the next 12 months. That would lead to a target price of almost $68 /share or + 30% from this morning’s quote.
Is that a reasonable goal? I think so and Standard and Poors agrees. They list CSC’s ‘fair value’ as $73 /share and now carry a 12-month target of $66. CSC shares changed hands at $60.40 and $63.80 at their peaks in calendar 2006 and 2007 when EPS were $3.62 and $3.84 versus the $5.00 expected in the FY wrapping up in March.
All in all CSC seems to offer decent appreciation potential with below average risk.
If you’re a believer and like to augment your selections with options you might want to consider this seven-month buy/write combination.
|Cash Outlay||Cash Inflow|
|Buy 1000 CSC @ $52.02 /share||$52,020|
|Sell 10 CSC Sep. $57.50 calls
@ $1.75 /share
|Sell 10 CSC Sep. $57.50 puts @
|Net Cash Out-of-Pocket||$43,270|
If CSC shares rise to $57.50 or better [+10.6%] by Sep. 17, 2010:
* The $57.50 calls will be exercised.
* You will sell your shares for $57,500.
* The $57.50 puts will expire worthless.
* You will have no further option obligations.
* You will end up with no CSC shares and $57,500 in cash.
This best-case scenario result would be a gain of $57,500 – $43,270 = $14,230
$14,230/$43,270 = 32.8% cash-on-cash.
That means any move up of 10.6% or greater by Sep. 17, 2010 would translate into a > 32% total return for those who bought and wrote as described here.
What’s the downside?
If CSC remains < $57.50 through Sep. 17, 2010:
* The $57.50 calls will expire worthless.
* The $57.50 puts will be exercised.
* You will be forced to buy an additional 1000 CSC shares.
* You will need to lay out another $57,500 in cash.
* You will have no further option obligations.
* You will end up with 2000 shares of CSC.
What’s the break-even on the whole trade?
On the original 1000 shares it’s the $52.02 purchase price less the $1.75 /share call premium = $50.27 /share.
On the ‘put’ shares it’s the $57.50 strike price less the $7 /share put premium = $50.50 /share.
Your overall break-even would be $50.39 /share or 3.14% below our trade inception price.
Computer Sciences is a high-quality, relatively predictable company that appears to offer at least 25% – 30% upside over the next 12 – 18 months.
Those willing to buy and write could see even larger gains in a shorter time horizon if CSC can attain even the $57.50 by mid-September.
Disclosure: Author is long CSC shares and short CSC options. I wrote about CSC previously on April 20, 2009 when the shares were trading at $37.98.