Review of Q3 2023

Sales fell by 1.6% y/y and roughly matched our expectations. Underlying sales is basically flat because there is one working day less in Q3 2023 relative to Q3 2022. The market stabilized during the quarter, although at a lower level than during last year. This market view aligns with what we hear from generalist IT consultants with some exposure to e-commerce. New sales was solid, and management believes Avensia has gained market share. However, sales to current customers continued to be weak due to a softer e-commerce market. While still in negative territory, it is a clear improvement relative to the -8% in Q2 this year.

An IT consultant’s sales are a function of the number of employees and their revenue per working day. In reality, the number of revenue-generating employees, i. e., excluding administrative personnel etc., would be a better measure. However, we cannot access those figures, making the total number of employees a reasonable proxy.

The number of employees at the end of the quarter decreased to 329 (359), corresponding to a y/y decline of 8%. Sequentially, the number of employees decreased by 25, and our forecast was -25. Avensia is actively working with its costs, which the solid margin improvement in this quarter clearly shows, meaning that Avensia, for example, is very selective when making replacement recruitments. The natural employee churn, which is at normal levels, combined with the very selective replacements, resulted in a lower headcount. As the utilization rate has not yet reached normal levels, despite the solid improvement in the quarter, we expect some further reductions in headcount (from natural churn), although at a lower magnitude.

The number of employees at the end of the quarter is a leading indicator for sales growth in the coming quarter. While sales is dependent on other parameters as well, the starting number of employees for the coming quarter is, together with the number of working days, the only relevant figures we know in advance.

Employee churn is typically costly for any company. However, as IT consultants’ sales generation depends on their employees in a nearly 1:1 ratio, we believe low employee churn is even more important in IT consultant firms.

As Avensia report its end-of-quarter headcount, we take the average of incoming and outgoing headcount as the average headcount for the period. However, in this case, looking at the per-employee data, we believe the lower outgoing number is closer to the average. This is because the Sales-COGS is rather low while the Contribution is very high (for a Q3 at least), implying a lower headcount than we use in the calculation. Also, our discussions with management supports that view. Thus, the “real” Sales-COGS per employee and working day most likely increased by more than 2% y/y, following improved utilization rates.

The Sales-COGS/employees/working day is a proxy for the revenue generation of one employee during one working day, indicating how advanced services the company provides and how high its utilisation rate is. While sub-consultants and reselling software and hardware can alter accuracy in this measure, we try to consider that by subtracting the cost of goods sold, which typically consists mainly of expenses related to sub-consultants and reselling. Also, as we use the total number of employees, the share of administrative personnel can alter the number. A high share of administrative personnel might not be unwanted. For example, when focusing on expansion, the investments in administration are typically front-loaded.

The Contribution/employee/working day is sales-cogs-personnel expenses and indicates the profit contribution for the average employee per working day. We believe it is a proxy of how much revenue consultants generate compared to their seniority and, thus, salary. For example, a high Sales-COGS/employees/working day might not be worth much to shareholders if most are paid as salaries to senior consultants.

Overall, OPEX was substantially lower than our forecast of SEK76m and amounted to SEK68m (106). Other external costs roughly matched our expectations, while personnel expenses were significantly below our forecasts as the cost per employee was lower than expected. Considering the 9.4% EBIT margin, especially in a Q3, which typically is weak for consulting firms, we believe the cost control has been very good - possibly too good for the long run, as some employee care, such as conferences, are important in the long run. Thus, we do not want to extrapolate the full extent of the strong Q3, where a stronger Q4 typically follows for seasonality reasons. Nevertheless, we believe Avensia showing it can be very profitable when prioritizing profitability is crucial to the investment case.

EBIT was SEK8.6m (-1.4), corresponding to an EBIT margin of 9.4% (-1.5). Our forecast was SEK3.5m and 3.9%, and the beat was due to significantly lower personnel expenses than anticipated. We are impressed with the margin of 9.4% in the seasonally weak Q3, a level higher than seen in most generalist IT consulting firms with low exposure to the weak e-commerce market. The cash flow was soft due to a negative contribution from net working capital. However, that is mainly for seasonality, as 30 September was a Saturday. We have seen a similar pattern in several IT consulting/software companies.

By the end of the quarter, Avensia had a net cash position of SEKc5m.

As common among IT consultants, Avensia has low CAPEX, and the cash conversion tends to be strong.

As Avensia, with this Q3 report, has reached solid profitability much earlier than we expected, we increase our short- and mid-term margin assumptions. However, as we already did believe Avensia would return to solid profitability in a few years, we only made minor adjustments to our long-term forecasts despite the strong Q3.

We leave our sales forecasts roughly unchanged for both 2023 and 2024 while raising our 2024 EBIT forecast by 56%, expecting a margin of 8.6% – thus, we do not extrapolate the strong Q3 fully at this point.

For the long run, we expect EBIT margins of 11-12%, starting from 2025 - a level among the highest in the sector.

We retain our Base Case to SEK13 (13), as the positive effect of increased forecasts – mostly short/mid-term – is neutralized by us increasing the risk-free rate from 2.5% to 3%, following higher market rates. While having a minor effect on our long-term forecasts, we believe the strong margin seen in this quarter is evidence that our expectations of EBIT margins of 11-12% in a stronger e-commerce market are very realistic, strengthening the likelihood of our Base/Bull Cases.

Avensia is trading at some discount to the peer average and median on 2025e. We believe the market does not agree with our assumption of the EBIT margin reaching 11% in 2025e. If Avensia achieves this, we expect it to trade at an EV/EBIT multiple, at least in line with the peer average.