Look for continued margin improvement at CGI Group, says Paradigm

Improved margins in the U.S. market helped drive a good quarter for CGI Group (TSX:GIB.A), and additional synergies from the company’s acquisition of Logica will continue to power its operating leverage, says Paradigm Capital analyst Gabriel Leung.

Yesterday, before market, CGI reported its Q3, 2014 results. The company earned $225.1-million on revenue of $2.7-billion, a topline that was up 3.9% from last year’s second quarter.

CEO Michael Roach characterized the quarter.

“Our team continues to deliver solid performance executing to our business plan and creating significant value for shareholders,” he said. “Our ability to generate more than a billion dollars in cash from operations over the last 12 months allowed us to reduce our net debt by $500-million and affords us significant operating flexibility to continue investing in our build and buy profitable growth strategy. Looking ahead, our focus is squarely on the conversion of new sales opportunities into bookings and high-quality growth, leveraging the strength of our diversified market coverage.”

Leung says he was generally pleased with the results of the quarter, in particular with the improvement in the company’s U.S. margins, which benefited in part from the wind-up of several problem contracts. Those gains were partially offset by a decline in margins in France, but the analyst believes those will recover, possibly representing upside later this year.

In the second quarter, CGI’s Adjusted EBIT margins were 12.8%, up from 12.6% in Q1, and bested Leung’s estimate of 11.7%.

Noting that there is still about $78-million in integration charges from the Logica that the company expects to pay down this year, Leung says the landmark acquisition will could continue to drive better than expected operating leverage for CGI.

In a research update to clients this morning, Leung maintained his “Buy” rating and $48.00 one-year target on CGI Group, implying a 23% return at the time of publication. Leung says his target is based on 9.5x his estimate for the company fiscal 2015 EV/EBITDA.