Adding Capgemini, Removing ARM Holdings
What's Changed — Today we launched European Technology – Tech Tones, a
report in which we rank-order the stocks in Citi’s European Technology coverage
within the Citi rating categories of Buy, Neutral and Sell. While we have no specific
formula for allocating the ranks, factors we take into consideration include business
conditions, upcoming catalysts and recent share price volatility. We have three
premises for positioning our overall framework 1) top-down preference for EU (QE)
exposure, over exposure to emerging markets (EM), and particularly China (~25%
of EU Tech sales), 2) focus on capital allocation & market leadership, and 3)
bottom-up view emphasizing earnings momentum and expectations setup. This
analysis triggers our removal of ARM Holding (ARM.L; Buy, £9.51) and addition of
Capgemini to Citi Focus List Europe.
Adding Capgemini — Our Buy recommendation is based on two premises - a)
improving revenue growth underpinned by structural shift toward greater
outsourcing and offshoring in Europe, and b) steady pace of margin expansion
driven by merger synergies and declining average remuneration per employee
(Please see our recent Beyond the Horizon for more detail). Our DCF-based target
price of €100 factors in medium-term top-line growth of 4-6%, reported EBIT margin
of 10-11%, terminal FCF growth of 1% and WACC of 7.4%. Enterprise Value (EV)
adjustment of ~EUR 1.3bn primarily includes pension provisions.
Removing ARM Holding — We retain our Buy recommendation but no longer
consider it as a top pick as slowing demand from China continues to weigh in
across semis. More importantly, emphasis on momentum has meant that impact on
stock has been stronger than the likely cut to earnings. And with our economists
seeing China risks tilted to the downside, near-term setup remains challenged,
despite our positive view on the firm’s long-term licensing and adoption
fundamentals. We value ARM on 32x 2016E EPS to arrive at our TP of 1160p. This
PE multiple reflects EPS CAGR of 20% and PEG multiple of 1.6x.