Over five years, PBT Group has returned nearly 320% in share price growth alone, never mind dividends.
By any standard, that’s remarkable. It’s a good reminder that when you successfully pick small caps, you can do incredibly well.
Waiting for a valuation catalyst isn’t enough, though. It’s a lot more powerful when the underlying earnings drive the share price. Eventually, if the market sees enough growth, the multiple will rerate. It certainly won’t happen on its own, no matter how many analysts may point to the multiples of international peers and shout about how much higher they are than the local company.
The pandemic was a wonderful driver for earnings at PBT, as corporates had to learn about concepts such as cloud migration and big data. This drives a need for data analysts and technology experts, as we saw on the global stage at the likes of Accenture.
Locally, PBT was the happy beneficiary of heightened levels of investment in critical IT projects, creating an opportunity to respond to that demand by staffing up and putting hourly billing relationships in place.
For context, PBT’s revenue in financial 2019 was R588m. In financial 2024, it was more than R1bn. That’s a revenue growth compound annual growth rate (CAGR) of 12.7%, a really impressive outcome over that length of time.
But here’s the bit that worries the market: in 2024, the growth was just 3%. That’s a slowdown of note, driven by client budgets coming under pressure and technology investments being rationalised.
Revenue is only part of the story, of course. If we move down the income statement to earnings before interest, tax, depreciation and amortisation (ebitda), we find an increase from R51.4m in 2019 to R138.5m, with a CAGR of 21.9%.
This is what the market enjoyed most over the pandemic period, with strong revenue growth driving even better margins. The ebitda margin improved from 8.7% in 2019 to 12.9% in 2024.
When modelling out a business and its prospects, it’s absolutely critical to remember that margin expansion cannot continue ad infinitum. There are practical limits to these things. If nothing else, you reach a point where sophisticated clients put pricing pressure on your margins, or new competitors enter a market to participate in a lucrative profit pool.
Unless you are Microsoft with a practically irreplaceable product offering, the margin squeeze eventually comes for you. If you’re lucky, there’s only minor pressure that leads to ebitda growth dipping slightly below revenue growth as margins are compressed. If you’re unlucky, you dish out a margin shock to the market and the share price suffers.
With ebitda down 5.6% despite revenue growing 3%, normalised headline earnings fell by 8.9% and the market had a rethink about growth prospects
PBT unfortunately falls into the latter category. As great as the ebitda CAGR from 2019 to 2024 may be, it’s the year-on-year move in ebitda that scared people. With ebitda down 5.6% despite revenue growing 3%, normalised headline earnings fell by 8.9% and the market had a rethink about growth prospects.
Five years ago, PBT was trading at about 150c, based on normalised headline earnings of 18.2c a share. That’s a p:e of about 8.2, so it wasn’t a bargain by small-cap standards before the pandemic. It was just heavily underpriced for the growth that was coming.
Based on 2024 numbers and the current share price, the p:e is now 9.7. The market has certainly taken a breather (the share price has lost about 17% in the past year) but is still giving the company more benefit than before about its growth prospects.
There’s also an element of visibility, as PBT was a relatively unknown stock before the pandemic.
Dividends also make a difference. There wasn’t a dividend in financial 2019. In financial 2024, the dividend was 60c a share, so the trailing dividend yield is 9.2%. The business is a cash cow, with most of the profits flowing through to investors.
Is the core business strong? Yes, but not impenetrable. The impact of competition and disruption from other sources (AI cannot be ignored) will come through in the margins in future, so that’s where the market will focus much of its attention. If the company has another year of ebitda shifting down, the share price multiple can easily take another knock and the dividend yield can move into double digits as the market gives up on growth.
The best chance for PBT will be growth in the financial services sector, which is its core client base. The new government has injected excitement into that sector, encouraging higher technology budgets to drive growth. At this dividend yield and with question marks around growth, PBT is a hold for now.
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