Richard Beddard: a good company with the mother of all strategies

These FTSE 250 shares have raced higher but are less expensive than they were. Have they fallen enough for our stocks expert to give them a top rating?

There is an irony in Softcat (LSE:SCT)’s performance for the year to July 2021. It was the company’s 16th consecutive year of profit growth, yet it was unable to do many of the things that make it so special.

The pandemic stopped the software and hardware reseller’s account managers from visiting their customers, and it emptied its offices where its legendary culture flourishes through events that motivate and train its people to sell more kit to more customers.

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It tried to engage. Top performers were still treated to lunch on the company, but they did not share it with each other, or their bosses.

Travel and events cost money and not doing as much saved Softcat £1 million a month. That saving, and a surge in demand as business and the public sector scrambled to enable their staff to work from home caused a 27% surge in profit, taking the company’s compound annual growth rate over the last seven years to nearly 20%.

Past performance is not a guide to future performance

While Softcat expects gross profit to continue growing in double figures in 2022, it anticipates operating profit will probably equal what it achieved in 2021 due to the return of travel and events, and investment, which at Softcat means recruitment and training.

The company employs 26% more people than it did two years ago, before the pandemic.

The mother of all strategies

Softcat’s purpose, stated on the front page of the annual report, is to “help customers use IT to succeed by putting our employees first.”

It is the mantra of many a formidable sales organisation, because to get customers to buy for the first time, or to return, you need to win their trust. That requires knowledgeable and motivated employees.

Softcat’s strategy is to sell more IT to existing customers and recruit more customers.

The company says that in 2017 it increased investment in recruiting and training specialist technical roles to “go deeper” into its customers’ IT budgets. Training in new technologies does not just increase the company’s relevance now, it convinces customers Softcat is a partner for the long haul.

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It is also seeking to grow internationally, primarily by servicing UK customers internationally through a number of overseas offices. It is beginning to serve overseas customers through those offices too.

Judging by the non-financial indicators published by the company, the strategy is working.

Even though lockdown restricted its opportunities to win new business, Softcat grew its customer base by more than 2%, and its share of customers’ business increased to 20%.

Since the company supplies 20% of its addressable market, its market share is about 4%.

The company’s employee engagement score was 93%, and customer satisfaction was 95%. It won recognition as usual, as an employer, reseller, and from its vendors.

In some ways, Softcat’s strategy is the mother of all strategies because motivated and trained staff should be able to respond to any challenge.

There seems little risk of complacency. The company was founded in 1993 by Peter Kelly, who wanted to create a company people would enjoy being part of.

He still owns 33% of the shares and has the unexercised right to nominate somebody to the board.

Chairman Martin Hellawell is the previous chief executive, responsible for much of the company’s extraordinary growth.

These people are probably guardians of the corporate culture, and Softcat emphasises this culture at every opportunity.

But it worries me slightly that Softcat says little about strategic challenges, the competitive environment, and the risk that the frenetic adoption of IT might one day subside, at least in its current form.

Scoring Softcat

The competitive environment is complicated. Resellers, of which Softcat is one of the biggest and fastest growing in the UK, simplify things for customers, advising them about technology and licensing options and bundling products and services that replace multiple vendor relationships with one.

But vendors sell direct too, which might be getting easier now software is increasingly sold as a service and there is no-longer a shrink-wrapped product to supply. Since Softcat’s 200 vendors are big innovative companies like Amazon Web Services and Microsoft, there may be a risk that customers get more used to buying and configuring their own services.

SAAS buying platforms are also emerging, which are introducing an element of automation into procurement and perhaps signalling that in future there will not always need to be as much of a personal touch buying IT.

Software houses and resellers are booming, though, as businesses move their infrastructure into the cloud, increasingly use data to derive insights into their businesses, and require higher levels of security to protect their more valuable information.

But these transitions may have a cyclical element like earlier waves of IT adoption. The internet bubble that ended in 2000 caused years of painful contraction at many IT resellers.

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The worst affected were disparagingly known as “box shifters”. They did not do much more than sell hardware and software in boxes.

Softcat’s average profit margin of 6% suggests that the value added by its expertise is limited, and I wonder if the strategy works as well in an environment, unimaginable though it is now, where IT spending is more constrained.

My doubts probably say more about my ignorance of IT, and I might be wrong for longer than I have left as an investor, but I would be lying if I did not admit to them.

Does the business make good money? [2]
+    High Return on Capital
+    Strong cash flow
?    Modest profit margin

What could stop it growing profitably? [1]
+    Very strong finances
?    Possibility IT investment wave will subside
?    Complex competitive landscape

How does its strategy address the risks? [2]
+    Investing in recruitment and training compounds people advantage
+    Staff trained and motivated to sell more IT to more customers
?    Strategy seems tuned to a growing market

Will we all benefit? [2]
+    Founder Peter Kelly owns 33%, has right to nominate a board member
+    Employee first culture puts customer first
?    High level variable pay earned current ceo £2.5 million in 2021

Is the share price low relative to profit? [-2]
−    No. A share price of £18.55 values the enterprise at nearly 36 times normalised profit.

A score of 5 out of 9 suggests that Softcat may be a good long-term investment, but I am a little wary about the potential for change.

Apparently, others are not concerned, because the share price is high too.

Softcat is ranked 28 out of the 40 companies I score in my Decision Engine.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.

For more information about Richard’s scoring and ranking system (the Decision Engine) and the Share Sleuth portfolio powered by this research, please read the FAQ.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard