AI Adoption And Long Term Managed Services Will Drive Powerful Upside Potential

Catalysts

About CGI

CGI provides IT services, consulting, managed services and IP-led solutions to public and private sector clients globally.

What are the underlying business or industry changes driving this perspective?

• Rapid adoption of AI in mission critical systems, supported by CGI's advanced AI investments, AI-enabled software delivery life cycle and high client interest in AI advisory and integration, positions the company to capture higher value projects that can support revenue and potentially lift earnings quality over time.
• Growing client focus on long term managed services relationships, with CGI embedding advanced AI as standard practice and reporting higher managed services bookings and a larger pipeline, supports visibility on recurring revenue and can be supportive for net margins as AI driven efficiencies scale.
• Expanding global alliances with major AI and cloud platforms such as Google Cloud, OpenAI, AWS, Snowflake, ServiceNow and UiPath, together with a large share of CGI IP and solutions already incorporating intelligent automation, creates more high value offerings that can support revenue and mix driven margin improvement.
• Ongoing consolidation of IT vendors by large enterprises and governments, where CGI is already winning multi year partnerships and vendor consolidation mandates, can increase wallet share per client and support both revenue and EBIT margins as outcome based and fixed price models benefit from AI and global delivery leverage.
• Active M&A program supported by a net debt leverage ratio of 1 and $2.4b of available capital resources, with recent acquisitions such as BJSS, Apside, the Comarch division and Online Business Systems already broadening capabilities and geographic reach, provides scope for continued accretive earnings contributions and supports long term EPS growth.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more optimistic perspective on CGI compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming CGI's revenue will grow by 3.3% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 10.5% today to 12.4% in 3 years time.
• The bullish analysts expect earnings to reach CA$2.3 billion (and earnings per share of CA$11.64) by about August 2029, up from CA$1.7 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 14.1x on those 2029 earnings, up from 12.1x today. This future PE is greater than the current PE for the US IT industry at 10.2x.
• The bullish analysts expect the number of shares outstanding to decline by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.73%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Prolonged or recurring U.S. federal government shutdowns, or wider political disruption around federal budgets and procurement, could keep utilization of U.S. Federal staff below capacity for longer periods. This would weigh on revenue from that segment and put pressure on EBIT margins and overall earnings.
• Enterprise AI adoption is described as a gradual journey that depends on complex prerequisites like data quality, application modernization and cybersecurity. Many clients have already paid for AI tools without yet seeing clear returns, so a slower than expected shift from experimentation to large scale deployment could limit AI related project work and delay any mix benefits for revenue and net margins.
• Clients are increasing vendor consolidation and shifting to outcome based and fixed price contracts. While this can support longer term relationships, it also raises execution and pricing risk for CGI if AI and global delivery efficiencies do not fully offset cost pressures, which could compress EBIT margins and earnings on some contracts.
• Government and defense clients worldwide are described as ramping digital and cybersecurity programs. Those budgets remain exposed to geopolitics, changing industrial policies and public finance constraints, so slower or deferred awards relative to the current pipeline could limit the conversion of backlog into revenue and affect earnings visibility.
• Large scale internal and client facing AI investments, along with ongoing M&A activity and integration costs, require sustained capital outlay. If acquired businesses or AI capabilities do not generate the anticipated demand, CGI could see weaker returns on invested capital, softer net margins and less support for long term EPS growth and buybacks.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for CGI is CA$150.0, which represents up to two standard deviations above the consensus price target of CA$120.77. This valuation is based on what can be assumed as the expectations of CGI's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$150.0, and the most bearish reporting a price target of just CA$95.0.
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2029, revenues will be CA$18.1 billion, earnings will come to CA$2.3 billion, and it would be trading on a PE ratio of 14.1x, assuming you use a discount rate of 8.7%.
• Given the current share price of CA$102.61, the analyst price target of CA$150.0 is 31.6% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.