IT consulting and managed services provider SMS Management & Technology Limited (ASX: SMX) has seen its share price crushed, falling 23% to $3.43 in late afternoon trading. That's despite the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) soaring more than 1.8%.
That follows a trading update from the company's CEO at today's AGM, which was light on details.
New CEO Jackie Korhonen reported that first half financial year (FY) 2016 earnings before interest, tax, depreciation and amortisation (EBITDA) is likely to be down between 15% and 20% compared to the previous period's EBITDA of $13.5 million.
It's going to be another disappointing result from a previous market darling. In the first half of FY14, SMS also managed to disappoint investors, when net profit plunged 55%, despite revenues rising 6% to $153.5 million. The 2015 first half result was a step up, with net profit rising 48% to $8.6 million after revenues rose 15% to $176.4 million.
Miss Korhonen said the fall in earnings is due to a number of factors including:
- Organisational restructure causing short-term issues for sales effectiveness, leading to a shortfall in revenue targets, and
- The wind-down of several major projects
Essentially, SMS is driven by market sentiment, IT investment cycles and project timing. If companies fear the outlook ahead, they tend to hold onto their cash rather than expense large capital projects. IT consultants such as SMS are one of the first in line to feel the impact of that. Miss Korhonen says that the company is confident of an improved second half performance.
It's an issue all companies feel when their major clients tighten the purse strings. IT contractors are also likely to see projects deferred or even postponed during tough economic environments. The yo-yo results from year to year certainly show that, and make it extraordinarily difficult to predict or forecast future earnings.
With the share price down more 52% since 2010, it also shows that investing in IT consulting companies can be hazardous to your wealth. ASG Group Limited (ASX: ASZ), another IT consulting and managed services company has seen its share price drop more than 17% over the same period while DWS Ltd (ASX: DWS) has seen its share price fall 16% in the past five years.
Foolish takeaway
All companies in the IT consulting sector are heavily dependent on company discretionary spending, which means they'll do well when their clients are flashing around their cash. But when tougher times arrive, it means less cash and contracts to go around. That means big trouble for consulting companies with a relatively large fixed cost base.
