June 8, 2017

ACN’s Uniform Adjusted EPS’ is well above traditional EPS, and recent underperformance is therefore likely unwarranted


  • ACN’s profitability is materially distorted by accounting for operating leases and stock options
  • As such, their UAFRS EPS’ is expected to reach $1.51 in Q3, not $1.04, and next year EPS’ is expected to reach $7.43, 35% higher than as-reported EPS estimates for the next four quarters
  • After making the appropriate UAFRS adjustments, ACN is not trading at a +20x P/E, but a 16.4x UAFRS-based P/E, which is below valuations of many peers

 

Accenture plc (ACN) is expected to release Q3 2017 GAAP EPS of $1.04 on 6/22, which would represent double-digit declines over EPS in the same period last year. Moreover, full-year estimates are similarly pessimistic, and are for EPS to decline by 3% in the next four quarters, from $5.74 in the four-quarter period ended Q2 2017, to $5.54. Given this slightly pessimistic outlook shares have languished, with ACN underperforming the market over the past year, as traditional valuations suggest a firm that is trading near fair value.

However, after making appropriate adjustments under Uniform Adjusted Financial Reporting Standards (UAFRS), it is apparent that earnings are actually far stronger than as-reported EPS suggests, and still growing, supporting current valuations, and further upside should these trends continue.

Specifically, under UAFRS, Uniform EPS (EPS’) is actually expected to reach $1.51 in Q3, nearly 50% greater than GAAP EPS, and is expected to grow by 4% in the next four quarters, not decline. EPS’ is expected to reach $7.43 in the next year, up 4% from $7.14 in the four-quarter period ended Q2 2017 and 35% greater than as-reported EPS. This indicates that valuations are not nearly as high as traditional P/E would suggest, and ACN is therefore trading at a slight discount to peers, not near fair value, and further upside and outperformance may be warranted.

The quarterly results show a similar trend, with EPS’ expected to remain well above as-reported EPS going forward, as it has in each of the past four quarters.

UAFRS, Uniform Adjusted Financial Reporting Standards, call for removal of distortions from issues like the treatment of operating leases and stock options. Once removed, it is apparent that ACN profitability is far greater than it initially appears, and as such shares are cheaper than investors may believe, suggesting further upside may be warranted.

UAFRS vs. As-Reported EPS

Investors make major decisions about which companies to own based on quarterly company earnings, the most common metric mentioned in traditional corporate investment analysis.

However, more often than not, the earnings that companies report in any given quarter can swing wildly and lead investors to completely wrong conclusions, because GAAP and IFRS rules force management to report results in ways that are not representative of the real operating performance of the business.

While there is a case to be made that some management teams can use “creative accounting” to adjust numbers, the research would show that more often than not, the real problem is with the accounting rules themselves, not management’s use of them.

The UAFRS Advisory Council has identified over 130 accounting and financial reporting inconsistencies (some of which can be found here), of which several have material impact on ACN’s financials.

Impact of Adjustments from GAAP to UAFRS

Two key UAFRS adjustments have the largest impact on ACN’s income statement, to get from earnings to UAFRS-adjusted earnings. These are related to operating leases and stock option expenses.

ACN’s operating lease expense is somewhat material. The decision management makes between investing in capex and investing in a lease is not a decision between an expense and an investment, but rather a decision in how management wants to finance their investments. If they would rather spend cash up front for the asset, they will spend capex. However, if they want to spread the cost of the asset over several years, they will instead choose to lease the asset. That said, as-reported accounting statements treat one as an investment, and the other as an expense that does not impact the balance sheet.

Meanwhile, stock option expenses are treated as an expense to the company in accounting statements, when they are actually a way for the company to give employees an ownership stake in the company. As such, this non-cash expense should be treated as dilution to equity holders and another claim against the Enterprise Value of the firm, as opposed to it being treated as an annual expense. This is especially true as, unless the company uses cash to buy shares (to suppress dilution for equity holders from the option grants being exercised), there is no cash impact on the company.

UAFRS-reporting adjusts for these traditional accounting distortions by treating all operating leases as an investing cash flow, and by rebucketing stock options into the firm’s Enterprise Value. These simple reclassifications remove a tremendous amount of accounting noise related to investment activities and improves investors understanding of the operating earnings of a business.

Greater-than-reported EPS’ suggests ACN is cheaper than it initially appears

At current prices, ACN is trading at a 20.8x traditional forward-P/E, which is around corporate averages, suggesting at first glance that the firm may be fairly valued, or even overvalued considering expected declines in as-reported EPS.

However, after making the necessary adjustments, it is apparent ACN is actually trading at a 16.4x UAFRS-based P/E, which is a below peer levels, and suggests a firm that may be trading at a discount when considering consistent EPS’ growth. Specifically, when compared to peers in the IT Consulting space, ACN is trading at a valuation below that of CTSH (21.0x UAFRS P/E), BAH (21.9x), LDOS (22.6x), and IT (105x) among others, suggesting should the firm sustain growth, multiple expansion may be justified.

By using Uniform Adjusted Financial Reporting Standards (UAFRS), investors see a cleaner picture that distorted GAAP and IFRS metrics cannot show. By standardizing financial reporting consistently across time and across companies, corporate performance and valuation metrics improve dramatically. Comparability of a company’s earnings over time, trends in corporate profitability and comparability in earnings power and earnings growth across close competitors and different sectors becomes far more relevant and reliable.

To find out more about Accenture plc and how their performance and market expectations compare to peers, click here to access the open beta of the Valens Research database.

Our Chief Investment Strategist, Joel Litman, chairs the Valens Research Committee, which is responsible for this article. Professor Litman is regarded globally for his expertise in financial statement analysis, fundamental research, and particularly Uniform Accounting, UAFRS.