Workday Demand And Global Digitalization Will Support Long-Term Prospects As Fair Valuation Case

Catalysts

About Kainos Group

Kainos Group provides digital transformation, Workday consulting and specialized software products to public sector, healthcare and commercial customers globally.

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

• Deepening product collaboration with Workday, including exclusive resale of Pay Transparency and participation in the Clear Skies initiative, is described as expanding addressable markets and supporting sustained double digit ARR growth, which in turn is expected to drive higher software led revenue and operating leverage.
• Structural demand for cloud based HR and finance platforms, combined with Workday’s continued global penetration, is cited as underpinning a long runway of implementation and follow on consulting work. This is expected to support growth in Workday Services revenue and margins supported by improved utilization.
• Ongoing digitization of government and healthcare services in the U.K. and Canada, evidenced by record digital services backlog and large multi year contracts, is presented as providing high visibility recurring project flows that can translate into steady top line expansion and margin recovery as contractor dependence falls.
• Rising regulatory and societal focus on pay equity, compliance and data security is expected to increase demand for Pay Transparency, EDM, Smart Test and Smart Shield, supporting premium pricing, resilient subscription revenue and structurally attractive net margins.
• International expansion, particularly in North America where revenue is reported as growing rapidly across all three divisions, is expected to diversify the customer base, improve scale efficiencies and enhance earnings growth as the mix shifts toward higher value geographies.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Kainos Group's revenue will grow by 9.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from 8.1% today to 13.5% in 3 years time.
• Analysts expect earnings to reach £67.9 million (and earnings per share of £0.48) by about December 2028, up from £30.7 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting £78.2 million in earnings, and the most bearish expecting £56.1 million.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 24.6x on those 2028 earnings, down from 42.1x today. This future PE is greater than the current PE for the GB IT industry at 24.1x.
• Analysts expect the number of shares outstanding to decline by 2.05% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.28%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Structural growth in Workday Products, evidenced by nine consecutive reporting periods of ARR expansion and a 19% increase in ARR in the last six months, could sustain compounded revenue growth and operating leverage, leading to a higher valuation multiple and rising earnings rather than a flat share price.
• The long-term EU Pay Transparency directive, combined with Kainos’ exclusive resale agreement with Workday and inclusion in the Clear Skies innovation program, materially expands the addressable market for new compliance focused products, which could accelerate ARR and profit growth and put upward pressure on the share price.
• Rapid international expansion, particularly in North America where revenue grew 19% and now exceeds one third of group revenue, along with high repeat business from existing clients at 85% of revenue and a Net Promoter Score of 70, may support sustained top line growth and improving net margins that would challenge the assumption of a flat valuation.
• Secular digitization of government and healthcare services in the U.K. and Canada, supported by a record digital services backlog and large multi year public sector contracts such as the passport data modernization program, could translate into durable revenue visibility and margin recovery as contractor usage normalizes, driving higher long-term earnings.
• Ongoing investment in AI capabilities, with over 300 government AI projects delivered and 65% of development teams already using AI tools, may enhance productivity and differentiate Kainos in high value digital and data work, improving gross margins and cash generation over time and supporting a rerating of the share price.

Valuation

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

• The analysts have a consensus price target of £11.25 for Kainos Group based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £12.5, and the most bearish reporting a price target of just £9.6.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be £504.5 million, earnings will come to £67.9 million, and it would be trading on a PE ratio of 24.6x, assuming you use a discount rate of 9.3%.
  
• Given the current share price of £10.83, the analyst price target of £11.25 is 3.7% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• 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.