Having made 9 millionaires, will Kainos Group bring prosperity to new shareholders?

Since their IPO, Kainos management and employees netted around £50.6m. That is the net proceeds from selling a 32% stake in the company. On that day, it made 9 new millionaires mostly for the founders and senior management.

N.B.: The company didn’t receive any proceeds from the Offer.

Having listed at £1.39 per share in the middle of 2015 the shares trades at £2.56 per share which represents a 90% capital appreciation in two years or 40% growth per annum.

Can this be sustainable?

As long as growth is maintained at the same trajectory of 20% to 30%. Also, they have many advantages working for them. But, first a breakdown of the company’s revenue, by division:

 Kainos revenue breakdown

One division that should impress you is Evolve, which provides instant access to data for healthcare organisation like the NHS in England. Their biggest division, Digital Services is solid with Workday Service showing similar growth to Evolve.

Now, onto the assessment of Kainos Group and the main topics covered are: –

 

  1. Kainos superior earnings;
  2. Kainos steady costs per employee, and growing output per worker;
  3. Kainos is pursuing a conservative accounting policy of choosing not to capitalise expenses;
  4. The cash “generativeness” of Kainos;
  5. Final thoughts, with 2017’s revenue and operating profits projection.

So, without further ado, let’s get started.

 

Kainos’ earnings

Starting with Kainos Group’s net margins. The chart shows a steady increase. By 2016, net profit margins became stagnant with net cash margin falling from 21.5% to 12.7%. So, how has that affected the numbers?

 Kainos Group margins

Kainos manage to increase net profit to £12.4m (vs. £9.76m) as net cash profit (see orange bar chart) fell to £9.76m (vs. £13.1m).

Now, we move onto understanding their staff costs.

Kainos costs of hiring talent 

In my previous article, I wrote about 1Spatial and why it was a growing business. The problem was they haven’t made a dime in profit. One of the blame came from the high costs of hiring talent.

For Kainos, staff costs are high but lower than 1Spatial. The big difference is Kainos staff are more productive. You see Kainos cost per employee is around £45k, but revenue per staff rising to £105k.

 Kainos Group cost per staff

The chart doesn’t look too important until you see the profit it produces per worker. 

Kainos has increased the profitability per worker to £19,000 from £10,000.

 Kainos Group profit per staff

Kainos not capitalising on expenses

Most technology businesses like to capitalise expenses because they believe it goes towards creating a new software that will be cash generative. The reality is no one knows.

Kainos took a different route and expense all its R&D expenditure.

A peek at “Non-Current Assets” shows a £3.36m figure in 2016, that’s similar to 2013’s £3.1m, despite doubling sales.

An easy way to detect non-capitalising of expenses is to use asset turnover (minus the cash). The ratio rose from 1.96 to 2.84.

 Kainos Group asset turnover

That means Kainos Group’s assets are generating more sales “per capita.” It also suggests the shareholders’ value looks to be understated.

If asset turnover saw a decline that means the assets are generating less sales and you should question the value placed in the first place!

 

Growth in Cash and Sales

And, finally, we come to cash generation.

Kainos Group revenue and cash

The chart shows the rise in revenue vs. the change in cash position. In 2016, there is a slight decrease in net cash of £1.7m. That was due to the big increase in dividends payout from £1.3m in 2015 to £13m (a 10-fold jump).

Excluding any big dividend, then you expect cash balance to break £25m, if Kainos decide to pay £3m in dividends (a 140% increase), instead of £13m.

Tip: – To assess the cash generated from a business. Add dividends back to the cash balance for each year that is analysed to get a true and fair view.

Kainos – Final Thoughts

Kainos is one of a few businesses that got listed on the market at the right time. A time when it is taking off!

Sure, management has sold some of their stakes, but they still control 37% of the company.

Fundamentally speaking, Kainos is growing quite rapidly, especially its sales. They carry no debt. Also, it generates growing amounts of free cash flow as capex is contained at £1m to £2m per year.

The company’s PE is 21 times, but net profit is growing at 27% which means it is slightly undervalued. The company pays a 4% dividend yield (£13.1m/£300m (MKT.CAP)), compared to the sector 2.32%. But, whether Kainos will maintain the level of payout is questionable.

Analysts (there are three) who are forecasting Kainos Earnings per share see similar results for 2017 and 2018 at 9.5 pence per share. That is bizarre!

In their latest trading update, they mentioned adding 216 staff since April 2016 to 975. That is a 25% increase! And going on their previous track record of £105,000 sales per staff and £20k profit per staff, then my forecast for Kainos Group’s 2017 is:

A. An approximate revenue of £102m from £76.6m;

B. And operating profit close to £20m from £14.2m.

The above are estimates.

Right now, the shares are a good value given the growth of its business.

 

So, what do you think of Kainos Group?

Have you made a profit from this company?

And, what do you think of their longevity?

Thanks for reading, and please share and subscribe!

 

Disclosure

The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.

Finally, the writer does not own the company’s stock, unless stated otherwise.