Stockwatch: time to buy this growth stock after a 37% rise in six months?

As recessionary clouds darken, can this company weather the storm and continue its advance, asks analyst Edmond Jackson.

In early dealings yesterday Cerillion (LSE:CER) rose 10% to 1,140p after this billing and customer management software group issued a bullish update. 

The situation keeps advancing a lot swifter than I expected when making a “buy” case last April at 820p. I targeted 1,000p on a two-year view but this took only three months to achieve, hence I moderated my stance to “hold” last July around 1,000p. 

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Have I underestimated Cerillion, or is it becoming frothy?  

Last springtime, its new customer pipeline had swelled by 31% to a record £172 million albeit with some churn. Total new orders had more than halved to £10.9 million, while those from existing customers were up 12%. 

As recessionary clouds darken, it is re-assuring now to read that orders and their pipeline remain strong such that annual revenue to 30 September is marginally ahead of expectations.  

But just how resilient is this kind of billing software, in support of telecommunications, finance, utilities and transportation? Vital though it may appear, is it not subject to wider trends in IT replacement, i.e. capital expenditure?  

Cerillion listed on AIM in March 2016 having originated as a 1999 management buy-out of the customer care and billing, product division of Logica. Companies House records, however, show that Cerillion incorporated only in March 2015, so we have yet to see how it can perform over a recession.  

In due respect to AIM as a source of emerging growth stocks, early buyers have seen Cerillion multiply 14-fold from 80p.  

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Despite profit-taking, the stock closed up 8% at 1,125p yesterday because its update cited “helpful” foreign exchange rates and lower finance costs contributing to profit materially ahead of recent expectations. 

Given that the dysfunctional effects of the UK’s mini-budget forced sterling lower right at the end of Cerillion’s year, the translation effect from its international revenues should be even better.   

Despite a modest £332 million capitalisation currently, its September 2021 year showed 72% of revenue deriving from Europe, 13% from the Americas, 8% from the Middle East/Africa and 7% from Asia-Pacific.  

From July’s interim results, the Americas have grown to 26% hence a strong US dollar looks to be helping.

While tricky to know exactly what UK revenues represent, continental Europe is implicitly material otherwise the exchange rate effect would not be. Moreover, this successful company is not forever moaning about Brexit.  

Mind the potential lumpiness of revenues 

Officially, Cerillion has some 80 customers in 44 countries, mostly second-tier telecom companies.

But in previous pieces, I have noted that within Europe, two customers accounted for just over 30% of group revenue in the September 2021 year; and in the first-half of 2022 the largest customer ramped up, while the second nearly halved. 

Together with an interim message of “bigger deals from larger customers” taking shape, it meant the possibility of lumpy numbers besides profits’ leverage. 

The transition to 5G mobile data looks to be driving this trend, which could be sustained a while yet. 

My hunch appears supported by this latest update citing Cerillion’s largest-ever contract in its fourth quarter. 

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From the interim results, recurring revenue constituted over 60%, which should help cushion revenue risks, but over years I have seen various examples of IT-type groups miss expectations simply over the timing of contracts versus reporting period dates. There is an immaterial effect on investment value but the stock market reacts emotively. 

Another aspect to be aware of is accrued income, a classic aspect of a contracting business, relying on management’s judgement of revenue where work has been undertaken but the client has yet to be invoiced. The September 2021 accounts showed this as nearly £10 million within £26 million overall revenue.  

Cerillion also offers longer payment terms to some customers, effectively providing them with finance, which makes sense as a cash-generative business although (say, in a recession) could lead to a rise in customers paying effectively in arrears.   

Meanwhile, and as a further sign of recent success, net cash is up 52% to £20.0 million in a balance sheet context of no debt beyond £3.5 million lease liabilities last March. There had even been £9,000 finance income instead of any charge, which must be growing. 

Also, a scant yield and high PE, lest the slightest caution creeps in 

Investors might reasonably wonder – for a company whose interim net cash from operations rose 145% to £6.5 million – why does it not pay a more material dividend? 

Around 9p to 10p a share is expected for the September 2022 and 2023 years, implying a prospective yield of barely 1%. Meanwhile, earnings cover has probably improved over 4x – at least in respect of 2022. 

If we generously assume Cerillion brings forward earnings per share (EPS) of 36p - as was the consensus forecast for September 2023 - to 2022, instead of 30p as previously expected, the forward price/earnings (PE) would still be over 31x.  

It is classic growth stock rating where you could defend retention of capital because return on capital employed is soaring over 30%.  

Yet the financial summary table also shows minimal capital expenditure, hence this cash really should be paid out to owners – if management is genuinely confident about prospects. 

Cerillion - financial summary
Year-end 30 Sep

Source: historic company REFS and company accounts

Such a rating cannot accommodate any adverse change in the story; hence holders need to believe Cerillion’s software is in a sweet spot, and able to resist recession. 

In fairness, I recall during the early 1990s that there were a very few growth stocks that emerged – such as Next (LSE:NXT) and Domestic & General insurance – contra the assumption, the economy was too difficult. 

The next insights as to trading will come with prelims due late November; a key test of the orders’ pipeline as wider business confidence deteriorates. Can Cerillion’s telecoms’ bias prove sufficiently defensive?  

Are growth stock ratings justified in the current environment? 

The broad reason they began falling from late last summer was over expectations that a long period of ultra-low interest rates was coming to an end. 

As interest rates rise, and because growth companies’ cash flows have longer horizons than cyclical industries, “growth” is perceived as less valuable. So-called value stocks (low PE and high yield) are supposedly preferred as interest rates rise. 

It is therefore odd how Cerillion’s rating has expanded just as central banks have had to jack up interest rates. I put this down to stock scarcity, by which I also mean relatively low liquidity. 

So, in addition to potential “revenue expectations miss” risk on a 12-months’ view, the context for growth PE’s is challenged. 

A case for taking at least some profits 

The stock’s advance appears to disregard some key risk factors both at the company and wider levels, making its risk/reward profile potentially unstable. 

Cerillion could, on a five-year view, remain a relative winner but a PE over 30x leaves no scope for disruption. 

A compromise is therefore to lock in at least some gains while expectations run high. I think “sell” is potentially harsh on a long-term view, hence broadly: Hold. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.