NCC Group plc Annual Report 2022

As technology companies struggle to make the right human capital decisions, companies like NCC Group are better able to navigate this type of environment having weathered the high attrition and wage inflation that is endemic to the cyber security sector. In essence, some companies like NCC Group are endowed with better DNA to navigate an inflationary environment. Another near-term disruptor is the risk of a recession, or even stagflation. Alongside inflation, the rapid undoing of the globalised Western soft power is feeding this sombre outlook. From the US–China trade war triggered bifurcation of the semiconductor supply chain to the fall-out from the Russia–Ukraine conflict, the global trade that underpins global GDP growth is now rife with uncertainty. This is epitomised by the symbolism of McDonald’s pulling out of Russia after three decades and its relevance to the author Thomas Friedman’s famous 1990s assertion that “no two countries that both have a McDonald’s have ever fought a war against each other”. This is changing how businesses look at risk. For example, supply chains are moving from lean methodologies like “just in time” to prioritising supply chain security. Similarly cyber security has taken more of a centre stage when it comes to operational risks. Russia’s outsized cyber capabilities were allegedly behind the very destructive 2017 NotPetya cyber-attack impacting over five dozen countries with total estimated damage running into double-digit billions of dollars. Couple this with the IP risks stemming from various trade wars, it’s easy to see why NCC Group’s cyber security consulting and software resilience solutions should find plenty of opportunities to mitigate the risks of global businesses. While much of what was discussed so far is a potential tailwind for NCC Group and its investors, not all near-term disruptors are tailwinds. The value of a company is determined by the future free cash flows (FCF) it could generate over the course of its lifetime. This value is calculated by “discounting” back all future FCF back to the present day using the cost of capital. As monetary policy results in a higher interest rate outlook, the cost of capital will rise. The inverse correlation between valuation and cost of capital will mean a reduction to the present value of these assets. We are already seeing this with the de-rating of publicly listed companies, as their future FCF are worth less in today’s money. “Valuation” is a relative thing, and over the long run, companies that produce strong, predictable and growing FCF tend to appreciate in value regardless of the monetary (e.g. interest rate outlook) or fiscal (e.g. taxation) regime. This is the ethos behind the idea that the stock market is a voting machine near term and a weighing machine longer term. At the very start, we mentioned how history tends to rhyme. The “Nifty-Fifty” bubble of the early 1970s is a perfect example of this voting vs weighting machine idea. As the charts demonstrate, the global names that constituted the “Nifty-Fifty” didn’t deliver much shareholder return during the inflationary environment of the 1970s. But the long-term holder will have experienced nearly 40x returns by 2021. This is why all stakeholders of NCC Group should remain focused on the long-term growth opportunity ahead of them while being nimble about short-term disruptions.

Chart 2: Nifty-Fifty stocks struggled over the near term… Source: Reuters

Relative S&P performance

1.2

1.0

0.8

0.6

0.4

0.2

0.0

P&G

Pepsi

Pfizer

Merck

Eli Lilly

CocaCola

IBM

Disney

J&J

Xerox

Amex

S&P 500

Chart 3: Only to materially outperform over the long term Source: Reuters

140.0 Relative S&P performance

120.0

100.0

80.0

60.0

40.0

20.0

0.0

P&G