Accenture's Q3 Results Fail High Expectations With AI Still Immaterial

Last month, we published an article on Accenture (NYSE:ACN) spotlighting the company's push into artificial intelligence. The stock has appreciated considerably since we published the article but has recently given up some gains after reporting its FYQ3 earnings which were decent but did not live up to heightened expectations reflected in the price appreciation. FYQ3 results are causing some investors to question if Accenture's bold AI investments will indeed bear fruit in a timely manner.

Accenture's vast commitment of $3 billion to AI-centric activities is a testament to its long-term growth strategy, yet it raises concerns about the uncertain timeline of significant returns from AI. Additionally, the company's lofty valuation, significantly higher than both the S&P 500 and its competitors, demands scrutiny. Is this premium justified by its robust AI strategy and expected growth, or are investors overpaying for potential yet to be realized? This article endeavors to delve deeper into Accenture's latest earnings, its AI ambitions, and its financial health to answer these pressing queries.

FYQ3 Analysis: By The Numbers

Accenture's FYQ3 earnings report and call showed better-than-expected results, with revenue and adjusted EPS at $16.57B and $3.19, respectively. This exceeds consensus estimates and shows an appreciable 5.1% FX-neutral revenue growth. Interestingly, this falls precisely at the midpoint of Accenture's previously guided growth range of 3-7%. However, results benefited from about $100M in foreign exchange increments relative to the guided values.

The company’s revenue performance was particularly strong in Health and Public Service (HPS) and Resources sectors. Communications, Media, and Technology (CMT), however, underperformed, experiencing a drop of 8% compared to the previous quarter, when it had remained fairly stable.

Accenture's FYQ3 operating margin was a solid 16.3%, up 23 basis points year over year. As for FY23 revenue guidance, Accenture has narrowed the upper limit from 8-10% to 8-9% FXN y/y, which disappointed investors. This suggests a 2-6% constant currency growth in F4Q, lower than the previous estimate of 6-10%.

The company's adjusted EPS guidance has shifted towards the upper half of the previously stated range, moving from $11.41-11.63 to $11.52-11.63. In terms of bookings, Accenture fell short of our estimate by approximately 6%, with fewer small deals coming through.

Accenture's clients appear to have shifted their emphasis away from short-cycle strategic consulting and systems integration work in favor of larger-scale, transformational deals. This could be because many enterprises are focusing on cost savings and operational efficiency in the current business environment.

Looking ahead, management expects FYQ4 bookings to remain flat from FQ3, suggesting a book-to-bill ratio of 1.07x. The top end of the 2-6% FYQ4 guide takes into account some possible improvements in small deals, while the lower end allows for potential further deterioration. We believe investors were disappointed with this outlook.

FYQ3 Earnings Focuses on AI

Accenture's recent focus on AI investment has been substantial and very forward-thinking, especially given its recent announcement to commit $3 billion to AI-related activities. In the earnings call, the company is also strengthening its relationships with major hyper-scalers, indicating a strategic move towards leveraging AI across its business operations.

Over the past four months, Accenture has managed to sell over 100 generative AI projects, totaling approximately $100 million in sales. While this figure might seem significant, it's worth noting that it isn't very material compared to the company's projected revenue of $64 billion for FY23.

However, Accenture's own research suggests that about half of all companies have yet to embark on their data or AI journeys. This presents a massive opportunity for Accenture, potentially catalyzing further demand for large-scale deals, particularly as companies seek to benefit from AI capabilities.

Expectations from investors for Accenture to capitalize on the AI trend were high for FYQ3 and FY23, given the anticipation that the company would be a major beneficiary of AI work. Although this expectation was not fully realized this quarter, there are indicators that Accenture could be a long-term leader in the AI space. Its substantial work in applying AI to supply chain and cybersecurity operations is a testament to this potential.

Accenture has also recently announced plans to double its AI workforce from 40,000 to 80,000, while simultaneously reporting that it has automated 13,000 jobs using AI technology. This shows the company's commitment to investing in AI and embracing the technology as part of its long-term growth strategy.

However, it's worth noting that while AI presents exciting opportunities for growth, its implementation and returns can take longer than initially expected. There's a risk of the market having overblown expectations about the speed at which AI can deliver significant benefits. While some companies, like Nvidia (NVDA), have been quick to reap the rewards, the AI journey is not the same for all companies, and the timeframe for realizing significant benefits can vary widely. Therefore, while Accenture's AI strategies present promising potential, it is crucial to temper immediate expectations with the understanding that AI's transformative effects will likely materialize in the long term.

Financial & Valuation

Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.

As discussed, Accenture's Q3 results proved somewhat mixed, with its stock trading down -1.9% following the earnings announcement.

Accenture's recent financial trends also demand attention. The company has experienced robust revenue growth, with a CAGR of 12.5% over the last three fiscal years, and the market expects this to continue, albeit at a slightly slower rate of 4.3% this fiscal year and 5.4% next fiscal year. The fact that Accenture's EPS growth over the past three years has outpaced its revenue growth demonstrates the company's efficiency in converting its top-line growth to the bottom line.

The consensus estimate of free cash flow reaching $8,526 million this fiscal year suggests a healthy cash position, albeit a slight contraction in FCF margin from 13.9% four fiscal years ago to 13.3% currently. Yet, considering the average FCF margin of 15.6% over the past four fiscal years, Accenture continues to demonstrate a strong ability to convert its earnings into cash. The low capex as a percentage of revenue, at 1.3%, indicates a capital-light business model, further contributing to the company's robust free cash flow generation.

Accenture's strong return on invested capital at 29.3% underscores the company's efficiency in utilizing its capital for generating profits. Coupled with a healthy balance sheet boasting a net cash of $8,481 million, Accenture looks to be in a strong financial position.

Nevertheless, ACN has underperformed over the past year, returning 10 percentage points less than the S&P 500. The stock's current price of $298.72 also lags 9% below its 52-week high of $327.93, despite being 7.3% above its 200-day moving average. However, with short interest at a low 1.2%, the market doesn't seem to be betting on a significant downward movement in the near term.

On valuation metrics, ACN seems to be trading at a premium relative to the S&P 500, with higher EV/Sales, EV/EBIT, P/E, and FCF multiples. Its PEG ratio of 2.5 also exceeds the S&P 500's 1.5, marking a 70.3% premium, which might raise some concerns about its relative value proposition.

Looking at historical valuations, ACN's forward 12-month P/E of 25.0 is just above its 5-year mean of 24.8, but still within its 2-standard deviation range of 16.4 to 33.2. This suggests that ACN's valuation, while slightly elevated, is not in the extreme territory when compared to its historical trends.

In comparison to peers, ACN trades at a higher forward 12-month P/E compared to BAH and IBM, which stand at 21.6 and 13.5, respectively. While this might be reflective of Accenture's superior growth profile, it does highlight that the company is trading at a premium to its direct competitors.

Conclusion

Despite mixed Q3 results, Accenture's robust revenue growth, strong cash position, and operational efficiency in converting top-line growth to the bottom line remain commendable. With a substantial push into AI, there's significant potential for the company to be a long-term leader in the space, though it's crucial to manage short-term expectations as the impact of AI could take longer to materialize.

However, ACN's premium valuation relative to the broader market and its peers might raise some eyebrows. Its relative performance to the S&P 500 and its peers suggests that the market might be pricing in Accenture's superior growth prospects. Nonetheless, investors should remain cognizant of the company's slightly elevated valuation, particularly in the context of its historical valuation range. As we move forward, observing how Accenture's AI ambitions translate into financial results and whether these strategic moves will justify the company's premium valuation are items of interest for us as we watch from the sidelines.