CGI Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

CGI Inc. is a global IT and business consulting services firm, offering a range of solutions from strategic IT consulting to systems integration, and managed IT outsourcing.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

CGI operates primarily as an IT and business consulting services firm. The company provides clients with end-to-end IT and business solutions. Their core services include consulting, systems integration, and managed IT outsourcing. This scope of offerings allows them to serve a diverse set of industries, including financial services, healthcare, manufacturing, government, and energy and utilities.

  • Revenue Distribution: CGI derives its revenue from three main segments:
    1. Consulting: This segment provides strategic IT advice, business process improvements, and digital transformation consulting services to clients. This includes services such as strategy and transformation, data analytics and AI, digital solutions, and business and IT consulting. 2. System Integration: This involves designing, developing, and implementing complex IT systems tailored to the specific needs of clients. These include enterprise solutions, managed security, application services and cloud migration and integration.
    2. Managed IT Outsourcing: This includes the management of client IT infrastructure, applications, and business processes over a long term. This offers a recurring revenue stream and has expanded to also include Cloud as-a-service products.
  • Industry Trends: The IT consulting industry is expected to experience modest growth in the coming years, largely driven by digital transformation efforts, cloud adoption, and increasing demand for data analytics. While there is no overall high growth rate expected due to saturation and a lot of new entries to the market, there is still a large market of services and recurring revenue. There is a demand for increased cybersecurity as well.
  • Competitive Landscape: The IT consulting landscape is highly competitive with numerous players ranging from large multinationals like Accenture, IBM, and TCS to mid sized companies and specialized firms. This creates a tough environment for companies to grow and make large margins, so many companies focus on maintaining relationships and winning clients over time instead of expecting rapid growth. Competition is based on technology, price, and relationship.
  • What Makes CGI Different? CGI focuses on building long-term relationships with its clients. CGI tends to be less hype-driven than competitors that offer new technologies on a short term basis. The company is often praised by analysts for their disciplined financial and management practices.
   Their recent focus has been on moving into recurring revenues by focusing on managed IT service outsourcing contracts, and the expansion of their cloud-based services offering.

Financial Deep Dive

  • Profitability & Margins: CGI’s profitability is moderately good. The company’s gross margins typically range around 27-31%, whereas its operating margins are close to 11-14%. EBITDA margin, used as a key metric in many firms in tech consulting, is around 15%. While these margins are relatively stable, and better than other providers in the sector, they are not that impressive compared to the wider software market. The company has recently implemented a “fit for growth” plan, which focuses on improving operational margins and efficiencies.
  • Growth: GIB has a slow, but steady organic growth and a relatively higher growth of their earnings over the years. They are focused on growth by expansion and partnerships that are often accretive. This is a steady, slow, but sustainable method of growth and is far less speculative than other companies.
  • Balance Sheet Health: CGI has a healthy balance sheet with a manageable level of debt and an increasing cash position. The company’s low Debt/EBITDA of 1.7 and Debt/Equity ratio of 0.35 show that the company is conservatively leveraged and can handle market downturns well. They also have a current ratio above 1, which indicates a better position to pay short term liabilities.
    • Debt: Total debt is about 2.8 times free cash flow, but the company is focusing on deleveraging in the next few years. There is no major debt maturity until 2026.
    • Cash: The company generates a large amount of free cash flow, and has a solid track record of returning it to shareholders through dividends and buybacks. The company has $1.7 billion in cash.
    • Goodwill: The goodwill on their balance sheet has steadily increased, and is now at $4.8 billion, almost 1/4 of the company’s assets. While the company has mentioned they carefully review the fair market value of goodwill every year, there is always a chance of impairment in these situations.
  • Shareholder Returns: CGI returns value to shareholders with dividends and buybacks. 2024 the company expects the return on capital to be 15 to 17% because of those initiatives, with a payout ratio of 20-30%. There is a history of consistent dividend payments going back to 2005.
  • Recent Concerns/Controversies/Problems: Recently, CGI has had some issues with some large contracts which have resulted in a decrease in their ROIC for 2023. This is mainly due to high inflation, problems with supply chain, and a few poorly priced contracts. GIB is currently focusing on working to renegotiate contracts, and focusing on high margin contracts. The company has indicated a target of 12-13% margins by 2027.
    • The company has also seen a drop in revenue growth lately, especially in consulting, but the company has said that is partly because of the push to move to higher revenue managed service contracts. This has put some downward pressure on their market multiple and investor sentiment, and can be seen as a risk going forward if management cannot successfully transition to this model. The company is also highly exposed to the government sector, so changes in regulation, budget, and spending can be a big risk to their profitability.

Moat Assessment (3/5)

CGI has a narrow moat that’s primarily due to switching costs and the long-term relationships they build with their clients. However, there are a lot of competitors in the market, which greatly increases risk for the company. * Switching Costs: Once a client has integrated its business with CGI’s systems, processes, and talent, they are less likely to switch unless competitors offer a significant economic advantage. * Long-Term Relationships: CGI emphasizes the establishment of trust and partnership with their clients. Since they focus on long term contracts, often 5-10 years or more, they become integrated in the long term strategy of the client, increasing switching costs and client retention. * The network effect may apply to their business to some extent, because more clients using the same system can create standards that are more useful to all the other customers of CGI, but we don’t see that network effect is an essential part of their business.

  • Legitimate Risks to the Moat:
    1. Competition: The IT and consulting industry is highly competitive, with a lot of competitors seeking to gain market share, which might affect margins.
    2. Technology: Rapid changes in technology might lead to the necessity of retooling or large capital expenditures in new technologies. Competitors may also be ahead of the curve on emerging technologies.
    3. Project Execution Risk: The complex nature of projects in their portfolio could lead to cost overruns, delays, or lower margins on certain projects.
    4. Government Spending Changes: The high reliance of GIB on government clients make them prone to changes in government budgets or political sentiment.
    5. Debt Burden: While it’s not high now, too much debt in the future could impede ability to expand or be flexible in market downturns.

Business Resilience

CGI has a fairly good business resilience as can be seen in their performance during the 2008 crisis and during the covid-19 pandemic.

  1. Recurring Revenue: A large part of the company revenue (around 45%) comes from managed service contracts, a more stable source of income compared to others.
  2. Diverse Client Base: The company serves a wide variety of industries, as opposed to having clients only in one sector. This helps mitigate any effects of specific market downturns.
  3. Experience and Expertise: GIB is an old, well-known company, and they have deep experience in what they are doing. Their staff is usually more highly skilled than their competitors.
  4. Financial Discipline: The company has shown restraint in leveraging the business, and a responsible and reasonable level of debt and expenses.

Understandability (3/5)

While the core business of CGI is straightforward—providing IT and business consulting services—a thorough evaluation requires an understanding of many factors, which are somewhat technical, making the business reasonably complex, and not very clear to a person not working in this sector.

  • It may be hard to assess the value of the services provided since they are not commodities and a client may not be able to compare services directly.
  • It may also be hard to understand if the management team is actually doing a good job of execution, as is often the case with businesses focused on long term contracts.

Balance Sheet Health (4/5)

CGI has a pretty strong balance sheet.

  • The company has a high cash position compared to their total debt.
  • They have a positive free cash flow for a long period of time, which allows them to pay dividends, buy back shares, and service debt obligations easily.
  • There are some questions regarding the valuation of goodwill, and it does take up a sizeable portion of assets. There is also a high level of operating leases.

Overall Analysis

CGI is a company with a solid management and financials, but their business, while offering recurring revenues, is not a sure way to build enormous moats. Competitors and rapid change in technologies do pose a threat. Therefore, it is more likely that CGI will offer long-term, slow but sustainable returns rather than large gains or hyper-growth.