Company Overview: The Citadel Group Limited (ASX: CGL) is involved in the expansion, development and distribution of technology and education solutions across Health, and other enterprises, national security, and defence. The company mainly focuses on managing complicated data by integrating technology know-how, systems, and people in order to provide information anytime and anywhere. A major portion of the company’s revenues are derived from software solutions and long-term managed services contracts. The company’s offerings are divided into three key segments – Knowledge, Health, and Technology. Incorporated in 2007, the company has more than 350 employees throughout Australia.

CGL Details

Higher Investments and Buyout Synergies are Key catalysts: The Citadel Group Limited (ASX: CGL) is an enterprise software and services company that focuses on handling information in complex surroundings via people, integrating know-how, and systems to offer data and information anywhere and anytime. The company remains on track to implement its Citadel 2.0 strategy, which will benefit the company to progress towards its strategy to increase the size of SaaS business, gain multiple contract wins, and leverage a substantial pipeline of opportunities. Growth in the SaaS business has been a key highlight for CGL business. Formed in 2007, the company has greater than 150 committed customer relationships and has worked with its top 10 clients for an average of more than 15 years.

Talking about 2019, the company witnessed a growth of 23% year over year from software/SaaS and related software services, under its Citadel 2.0 strategy. The company also made a higher investment in expanding the platform capabilities of the Citadel-IX offering, which increased the company’s customer engagement, positioning the Group with significant opportunities to scale. Moreover, the company also secured additional contracts in Defence and National Security. Also, the company’s Citadel-IX offering has experienced a whopping 157% revenue growth in FY19 and will position the company for a consistent recurring revenue stream from a significantly larger and diverse client base. The company also effectively exceeded all of its service level contracts and retained the highest level of delivery quality and information security to its clients. This has led to an enhancement to its already remarkable status.

Coming to 1HFY20, the company has made significant efforts to enhance its software and platform capabilities. During the period, the company successfully integrated Noventus acquisition realising $10.9 million of revenue and bolstering its offerings in the Government, Defence and National Security verticals.

Over a period of 1HFY16-1HFY20, Software revenue from continuing operations has reported a CAGR of 29.1%, with continuous upward movement. The return on investments made for developing the platform capabilities was apparent by the success of the Citadel-IX offering, which reported revenue growth of 15% from 1HFY19. Citadel-IX has over 25,500 users in 1HFY20 and the company is seeking to have more than 200,000 users by end FY21. Looking at the current business scenario, the trend is expected to be continued as the company confides in the investments made on developing its capabilities during FY20.

Track Record of Revenue (Source: Company Reports) 

Cloud computing is crucial to the future of the technology industry. It is prudent to say that cloud-based software solutions stocks are well-positioned in this fast-advancing space and is likely to boost investors’ confidence in the long-term. The global pandemic has shed light on the importance of cloud computing. With the world working from home, companies are depending more on this technology more than ever. With decent industry growth, CGL remains committed to continue with higher investments to create long-term value for its shareholders. 

1HFY20 Key Highlights: In 1HFY20 for the period ended 31 December 2019, the company’s total revenue stood at $61.1 million, up 24.4% from the prior corresponding period. The company’s shift in the business mix along with International expansion positively impacted quarter’s performance. Notably, in 1HFY20, total software revenues rose 18.9% year over year and stood at $18.9 billion, which comprised 31% of the total revenue. The increase was on the back of higher investments made for the development of secure cloud-based software solutions. Total service revenues, on the other hand, increased a whopping 25% year over year in 1HFY20 and comprised 69% of the total revenue. In addition, the company extended the 10-year contract with Queensland Health.  Gross margins during the period stood at 41.2%, down from 47.5% in the year-ago period. EBITDA for the period stood at $12.5 million, a decline of 5.3% on pcp. EBITDA for the period incorporated $800k of restructuring costs and one-off expenses, which more than offset the positive impact of AASB16 adjustments of $1.1 million.

Key Highlights (Source: Company Reports)

Balance Sheet Highlight: At the end of the period, the company’s cash balance stood at $12.3 million and total assets amounted to $151.8 million. The company has a debt of $19.6 million as of 31st December 2019 as compared to $12 million as at 30 June 2020, primarily due to draw down on debt facility to fund the Noventus acquisition. During the period, cash from operations came in at $5.1 million. In 1HFY20, the company declared a dividend of 4.8 cps.

Wellbeing Software Acquisition: On 6 April 2020, the company completed the acquisition of Wellbeing Software Group Limited (Wellbeing) for consideration of £103 million. The Wellbeing acquisition will assist CGL to leverage several growth possibilities and alter its business into a global healthcare software company. Wellbeing has come up stronger and responded well to reduce COVID-19 led crisis, by ensuring business continuity and support all customers. The move is a part of CGL’s strategy to bolster its foothold in the healthcare software sector in the United Kingdom. The company had predicted that post the buyout of Wellbeing, CGL will have a combined cash balance of ~$10 million as well as an additional undrawn working capital facility of ~$10 million.

Recent Updates:

1. On 23 July 2020, the company announced that Mr Graham Ridgway will retire from its post as a senior executive of the company, due to a change in family health circumstances, effective from 1 August 2020. Consequently, CGL advises the market that 732,009 fully paid ordinary shares held in escrow and owned by Mr Graham Ridgway, will be released from the voluntary escrow on the same date.

2. In another update, the company stated that Jayne Shaw, a Director in the company acquired 50,500 ordinary shares.

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table which together form around 60.04% of the total shareholding. Jakeman Holding Co Pty. Ltd. holds the maximum number of shares with a percentage holding of 8.57%, followed by Mcconnell (Mark) with a holding of 7.69%.

 Top Ten Shareholders (Source: Thomson Reuters)

Key Metrics: In 1HFY20, the company reported an EBITDA margin of 20.6%, higher than June’19 EBITDA margin of 4%. In 1HFY20, the company reported an operating margin of 11.3%, higher than June’19 margin of 10.5%. ROE in 1HFY20 stood at 4.1%, higher than June’19 ROE of 3.3%. Debt levels for 1HFY20 also stood at decent levels, with a debt-to-equity multiple of 0.31x, lower than the industry median of 0.49x. The company is confident about business growth, looking at the potential impact on gross margin from SaaS offerings like Citadel-IX.

Key Metrics (Source: Thomson Reuters)

Key Risk: On the flip side, loss of any key contracts and key personnel, failure to commercialise R&D expenditure along with disruption through technological advances or product failures remain a potential headwind for the company. Further, stiff competition in the market and debt-laden balance sheet add to the woes.

Outlook: For FY20, CGL expects revenues to be in the band of $128-$132 million and EBITDA to be between $28-$30 million. The successful integration of Noventus acquisition is expected to achieve over $20 million revenue in FY20, representing an increase of more than 11% on expectations. Further, post Wellbeing buyout, CGL expects to diversify its recurring revenue base, with recurring revenues increasing in the range of 41% to 48% of FY20 pro forma revenue. The company remains on track to invest in core Health and Enterprise Software and focus on developing secure cloud-based software solutions that have large addressable markets.

The company has been on track to increase the size of SaaS business, gain multiple contract wins, and leverage a substantial pipeline of opportunities. The company has made an investment in developing the platform capabilities of the Citadel-IX offering, which increased the company’s customer engagement, positioning the Group with significant opportunities to scale. Higher investments to enhance the cyber security capabilities and fight back the rising malicious cyber activity will aid the company to strengthen its foothold in the space. With an increased focus on digital enablement and curbing the risk in all aspects of emerging technologies including cyber, data, AI, and cloud, the company stands to benefit from the long-term profit and recurring revenue streams.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: The stock of the company went up 17.67% over a period of one month. Currently, the stock is trading close to the average of its 52-weeks trading range of $1.205 - $5.92. The stock is currently trading at a P/E multiple of 29.6x, with an annual dividend yield of 2.9%. The company is focusing to make higher investments for product enhancements and new technological capabilities. CGL has implemented various contracts that will support revenue growth in the coming years. We have valued the stock using a P/E multiple based illustrative relative valuation method and arrived at a target price offering an upside of high single-digit (in percentage terms). Considering the key business developments, expected contribution from acquisitions and contracts, and anticipated growth in the SaaS business and valuation, we give a “Buy” recommendation on the stock at the current market price of $3.62, down 2.949% on 31 July 2020.

CGL Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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