In the May 2014 issue of the Investor Advisory Service, we recommended EPAM Systems (EPAM), a fast-growing consulting services company. How has its stock performed in the year since, and what's ahead for EPAM Systems?
At the time of our investment comments last May, we noted tepid growth in Europe and slowing growth in Japan as ongoing global concerns. A year later, the Euro Area is showing signs of picking up, with the International Monetary Fund (IMF) projecting 1.5% GDP growth this year versus 0.9% last year. And after contracting 0.1% last year, a weaker yen and lower oil prices are expected to boost GDP growth in Japan to 1.0% this year. The U.S. is expected to continue to lead the rebound in the advanced economies, with the IMF forecasting 3.1% growth this year.
However, while advanced economies are doing better, growth forecasts for emerging and developing economies (with the exception of India) have weakened. This is mainly because the consumer does not benefit as much from the fall in energy prices in emerging markets, while at the same time many emerging markets are big oil exporters. We mentioned slowing growth in China as a key concern last May, and that continues to be an issue. The IMF expects China’s GDP growth to slow from 7.4% to a still impressive 6.8% this year, as the Chinese authorities have been forced to slow investment spending to compensate for the recent rapid expansion in credit and investment. Two of the other members of the previously formidable BRIC economies, Brazil and Russia, are expected to be the worst performers of 2015, projected to contract 1.0% and 3.8%, respectively. The Commonwealth of Independent States (CIS), excluding Russia, had the worst downward revision of any region from the IMF’s last round of projections.
One of the three companies we profiled in last May’s IAS, EPAM Systems (NYSE: EPAM), actually delivers a decent portion of its software engineering and programming services in the CIS region. With the poor economic outlook, volatile currency, and ongoing geopolitical turmoil in the region, it would be reasonable to think EPAM’s business and stock price would have performed poorly. Not the case. EPAM’s stock was a big winner over the last year, more than doubling from $31 at the time we profiled it to the current market price in the high $60s. This was the result of extremely impressive revenue and earnings growth in the face of the aforementioned significant headwinds in the company’s CIS segment. These headwinds led to a 15% decline in annual revenue in the CIS region, but EPAM more than made up for it by growing its two largest segments, North America and Europe, by 30% and 42% respectively.
Unlike the CIS region, EPAM stock was fairly stable in its ascent higher. This was driven by consistently exceptional business results. The company beat Wall Street’s consensus estimates on both the top and bottom-lines all four quarters last year. The shares immediately popped 5% and began a steady climb to the low $40s after EPAM reported Q1 revenue and adjusted EPS growth of 29% and 34% last May. The company proceeded to post blowout Q2 and Q3 results in August and November, reporting greater than 30% growth in revenues and adjusted EPS in both quarters. These strong fundamentals drove the stock above the $50 mark, before it consolidated in the high $40s prior to its next leg up. Then when the ruble and oil prices both finally reversed their tumble in the first quarter of 2015, the stock began its next rally into the mid $50s. Another earnings beat for Q4, with revenue up 28% and adjusted EPS up 29%, helped propel the stock into the high $60s, where it currently trades.
EPAM stock’s fundamental and technical performance has been strong enough for it to make IBD 50 status, Investor Business Daily’s list of the most elite stocks based on earnings, share price performance, and other factors. While we don’t place any real emphasis on technical analysis like IBD does, it is certainly true that EPAM stock has been breaking out lately, up over 40% year-to-date. We like to focus on the fundamentals and competitive advantage of EPAM’s business, which is just as strong as the stock’s technicals. The technical aptitude and lower cost of EPAM’s software engineers and programmers, one third of whom are based in Russia and Ukraine, has allowed it to compete successfully with bigger rivals like Accenture and Infosys for contracts from large global customers. EPAM develops software for a growing list of impressive corporate customers including Google, eBay, SAP, Expedia, Barclays, and Coca Cola. If a programming titan like Google chooses to outsource some of its development to a tiny guy like EPAM Systems, you can rest assured EPAM’s services provide some serious value added.
Like most hyper-growth stocks, EPAM appears very expensive at 48 times trailing 12-month earnings. However, at about 19 times analyst consensus estimated next 12-month earnings, the shares look far more reasonable. The obvious risk of looking at valuation on a forward basis is that the high growth rate fails to materialize in the future. However, EPAM’s strong past fundamental performance and competitive advantage make it a strong potential high risk, high reward play.