Overview
My previous call for a hold rating was right as the Gartner (NYSE:IT) is pretty much flat since the start of February (except it went for a 15% dive before recovering). From a business perspective, IT continues to perform well. All three of the company’s most important metrics improved from the previous quarter: Revenue, EBITDA, and net income. Despite this macro uncertainty, I believe IT did quite well qualitatively, as both research CV growth and conference attendance were robust. As I mentioned before, IT has a good chance of exceeding its 2023 EBITDA margin target on the strength of the order book. This became a reality when the EBITDA margin in the first quarter exceeded expectations, allowing management to raise their guidance from 21.5% to 22.5%. Based on this momentum, I expect more margin revision over the course of this year as IT leverages its fixed cost base.
However, I am still not confident enough to recommend a buy rating (large position) given the valuation (33x PE). As such, I continue to reiterate a hold position, but investors can look to accumulate small positions whenever the stock dips to ~28/29x earnings as historical valuation over the past decade suggests that is the range to accumulate as valuation tends to revert to mean.
Resilient business supports a high valuation
IT has proven once again that it can grow its business steadily by posting another prosperous quarterly performance. In spite of the uncertain macro backdrop, the value of its Research contracts grew by a healthy 10% year over year in 1Q, with 9% growth in GTS and 16% growth in GBS. Given that 70% of the CV in the Research segment is supported by multi-year contracts, I expect growth to continue being stable. This means that approximately 56% of IT revenue is secured through legally binding contracts. Consequently, IT saw generally stable customer sales cycles in 1Q, apart from the weak performance among tech vendor customers. Comparatively, to many other TMT stock names, I think this business characteristic has put IT into the spotlight (especially in the current investing climate), and hence, has drawn in many capital fund flows which is supporting the high valuation. If we look back at IT operating history, the business had never printed a negative growth rate over the past 12 years except during Covid, which I consider an outlier.
Since IT has already made the required investment (in terms of hiring), and since there is a better chance of a recovery in FY24 than in FY23, I am optimistic that the Research segment will continue to see healthy growth in the near term. Managers have stressed that, despite the current labor shortage, they are able to fill open positions in the Research sales department and will continue to be adaptable in this regard so that the company can ride the wave of short-term trends.
Consulting/Conference segment
Despite the fact that 70% of the Research CV is comprised of multi-year contracts, rapid expansion is challenging unless a number of extremely large contracts suddenly become available. To make up for it, in my opinion, the Consulting/Conference sector of IT serves a similar purpose, albeit with more cyclicality. I believe the toughest time is likely over for this segment (covid) and that things are starting to normalize from now on. The belief is reinforced by the consulting firm’s 1Q results (10% growth). Importantly, there are no indications of a decrease in demand, and the strong backlog of labor-based revenue suggests that growth will continue throughout the entire year. Revenue growth was also healthy in the Conference sector as a result of renewed interest in attending and exhibiting at live events. I expect this growth momentum to continue, with much more room to recover as the number of in-person conferences is still ~30% lower than 2019 levels (47 planned in 2023 vs 72 conducted in 2019).
Valuation
While I do not advocate for a long position at 33x PE, I believe opportunities to buy the stock will present themselves eventually, as they did in the last two months when the stock fell to 28x forward PE. IT has traded in the 29x to 38x forward PE range for the past ten years, with the exception of two years when the stock traded above 40x. When those years are removed, it is clear that whenever the stock trades at 29x, it tends to revert to 33x. This happened again last month. Given that the fundamental part of the business has received a lot of attention, it is difficult to determine the best time to buy the stock (for example, when the stock traded down to a low 20x PE). As a result, small positions are the only way to accumulate.
Risks
IT still has exposure to tech vendor clients (1/4 of Research CV), so there is risk with the remaining portion of revenue despite having 70% in multi-year contract. If the tech industry continues to face headwinds, it will have an indirect effect on IT. Consulting is both cyclical and discretionary, so even though IT hasn’t seen a slowdown in demand, a macro slowdown could still hurt revenue performance.
Conclusion
IT has demonstrated its ability to maintain steady business growth and deliver positive quarterly results. Despite macro uncertainties, the Research segment, supported by multi-year contracts, shows stable growth potential. I believe IT resilient business model has attracted capital fund flows into the name, which has supported the high valuation even in the current weak investing sentiment. Although the current valuation may not warrant a long position, historical trends suggest opportunities to accumulate the stock when it dips to around 28/29x earnings.
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