CGI long-term prospects bright despite hit to reputation from Obamacare: analysts

MONTREAL – CGI’s reputation has taken a short-term beating due to its role in launching the Obamacare website in the U.S., but the information technology company’s long-term forecasts remain bright because of a blockbuster European acquisition, industry analysts say.

The Montreal-based company has been featured in news reports in the United States and Canada due to troubles Americans have faced in signing up to the government’s new health-care plan. A senior vice-president of CGI Federal testified before Congress that it was the government’s responsibility — not the contractor’s — to test the website and make sure it worked.

“We believe that these challenges will largely be offset by an improving backdrop in Europe (not to mention the tail wind of an appreciating euro), which is a much larger component of CGI’s business,” Thanos Moschopoulos of BMO Capital Markets wrote in a report.

Europe accounts for 55 per cent CGI’s total revenues, compared with 13.5 per cent for U.S. federal government business.

But the analyst said questions about CGI’s performance could undermine the medium-term prospects for its U.S. federal business. He suggests CGI Federal’s revenues will decrease by eight per cent this fiscal year and by 12 per cent in fiscal 2015.

Moschopoulos said he doesn’t think CGI will be found to be the main party at fault because other companies were responsible for key portions of the system, including system testing.

“Nonetheless, we hardly expect CGI to emerge blameless once the full post-mortem is complete,” he wrote, pointing to testimony from a project manager that CGI Federal had “some issues with timely delivery.”

CGI (TSX:GIB.A) will report its fourth-quarter results on Thursday.

Its adjusted earnings are expected to soar to 62 cents per share, up from 39 cents per share a year earlier before it acquired Europe’s Logica, according to analysts polled by Thomson Reuters. Revenue was forecast to increase 56 per cent to $2.5 billion.

Pre-tax operating income (EBITDA) was estimated at $388.4 million, up from $192.7 million a year earlier.

For the full year, CGI was expected to earn $2.25 per share, or $711.7 million, in adjusted profits on $10.14 billion of revenues. Including one-time items, net income was expected to reach $497.5 million while EBITDA was forecast to nearly double to $1.46 billion.

Steven Li of Raymond James expects margins will continue to improve across all regions again in the fourth quarter despite the “headline risk” from Obamacare glitches.

“In our view, likely a distraction near-term which might lead to some booking slippage in the fourth quarter, but if resolved in a timely manner could give a boost to CGI.”

Analyst Paul Treiber of RBC Capital Markets expects Europe will be seasonally soft, down six per cent from the third quarter, U.S. revenues will rise 10 per cent and Canada to be down nine per cent due to seasonality.

While he agrees there’s a risk that CGI’s reputation may take a hit in the near-term, Treiber described the “long-term impact (as) likely nominal.”

CGI’s U.S. Federal business is much broader than Obamacare and health care, he said. The Department of Health accounted for 17 per cent of U.S. Federal contracts, below the 41 per cent by the U.S. Defense Department and 23 per cent by the State Department.

Treiber cited two cases, including IBM, where suppliers faced nominal fallout after being part of U.S. government contracts that were late, over budget or poorly performing.

The person appointed by the White House to manage the health-care project has said the website will be fully functional by the end of November.

“A properly functioning website will further reduce the media attention on CGI’s role in the website,” he wrote. “Conversely, negative headlines may flare up again if the website continues to malfunction.”

Scott Penner of TD Securities said investors shouldn’t be concerned about the Obamacare website issues, saying the key problem centred on the lack of testing by the Centers for Medicaid and Medicare.

“CGI’s testimony alluded to its revenue from the federal exchange being more than twice what was originally press released, given change orders from the government.”

On the Toronto Stock Exchange, CGI’s shares closed up 97 cents, or 2.68 per cent, at $37.11.