Sangoma Technologies Corporation (TSXV: STC) is a provider of hardware and software components that enable Internet protocol communications systems for both telecom and datacom applications. The Company is engaged in the development, manufacturing, distribution and support of voice and data connectivity components for software-based communication applications.

Revenue Mix

 

Investment Rationale

• Revenue and EBITDA are expected to exceed previous guidance: Sangoma has delivered a strong performance in FY21 especially given the unusual challenges of the global Covid pandemic. It is reassuring to see continued momentum in the business during these difficult times, and the company is especially gratified to finish the year on a strong note. Sangoma is expected to exceed its previously announced guidance. The management expects sales to be approximately CAD 167 million (up from CAD 166 million in the prior guidance on May 20) and EBITDA to exceed the CAD 30 million the company had indicated in their most recent forecast. Both measures include the fourth-quarter results from the March 31 acquisition of Star2Star.

• Ranked in Top-5 Omdia's UC as a Service (UCaaS) Scorecard in North America: Sangoma Technologies Corporation is a trusted leader in delivering cloud-native Communications-as-a-Service solutions for businesses of all sizes. Recently, the company ranked amongst the top 5 UCaaS providers in North America in the annual Omdia UC as a Service (UCaaS) Scorecard. Media, a global technology research consulting firm, derives its research from Informa Tech brands and the acquired IHS Markit technology research portfolio.

• Reported Margin Improvement and Increased Adjusted Cash Flow in Q3FY21: During the third quarter of 2021, the company generated a Gross profit of CAD 23.24 million, delivering a gross margin of approximately 66% of revenue up slightly from last year. EBITDA was CAD 6.63 million in the third quarter, up by about 2% versus the same quarter last year. EBITDA is 19% of total sales this quarter, up from about 18% in the third quarter of fiscal 2020.

• Decent Free Cash Flow Yield of 3.8%: The company's free cash flow yield of 3.8% provide a margin of safety to the present and potential investors amid heightened volatility in the global equity market. Further, the company's ability to generate free cash flow indicates the strength of the business model.

• Higher Institutional Ownership: Regardless of the company's penny cap market capitalization, the company has higher institutional ownership with institutional ownership of approximately 22.33%, with Star2Star Holdings LLC, BMO Asset Management, and Mawer Investment Management Ltd are among the institutional investors in the company. Higher institutional ownership in a penny cap stock provide confidence to the retail investors and also, to some extent, exhibits the strong fundamentals of the company.

• Gaining Technical Strength: STC shares are hovering above its crucial short-term support level of 50-day SMA, which would act as a crucial support level. Also, the 14-day period RSI is consistently hovering above 50, which indicates that the stock is no more in the bearish zone, and a potential upside is expected from the current trading level. Also, its shares registered a bullish engulfing pattern on the last trading session, where it engulfed the previous bearish candle and moved up. Moreover, the stock has taken support near the lower Bollinger Band© and bounced back in the last trading session, which is a bullish indicator. Therefore, given the above technical indicators, we expect an upside move in the stock from the current trading levels.  

 Technical Price Chart (as on September 21, 2021). Analysis by Kalkine Group

• Sustaining above the Rising Trend Line: On the weekly price chart, the STC stock prices are hovering around the rising trendline support zone and prices are sustaining above the trend line support level of CAD 2.86. Moreover, the prices are trading above the trend-following indicator 21-period SMA which may act as a crucial support level for the prices. Furthermore, the momentum oscillator RSI (14-period) is trading at 46.92 level.

Source: REFINITIV, Analysis by Kalkine Group

• Risk Associated to Investment: The company is exposed to variety of risks ranging from: intense competition, price war, change in technology, regulatory risks, changes in license fees, forex risks and interest rate risks.
  

Financial Highlights: Q3FY21

Source: Company Filing

• During the quarter under consideration, the company’s reported sales were CAD 35.44 million as compared to CAD 36.31 million in the same period of the corresponding previous financial year, which implies a degrowth of 2% on a YoY basis. For this period, the comparison was materially affected by the significant and rapid swing in exchange rates between quarters.
• However, when measured in US dollars, sales in the quarter ended March 31, 2021, were 5% higher than in the third quarter of fiscal 2020 and were 3% higher than in the immediately preceding quarter.
• This increase was driven by the company’s services business that continue to grow well at 15% this quarter compared to the same quarter last year as measured in US dollars.
• The cost of sales for the quarter ended March 31, 2021 was CAD 12.19 million compared to CAD 12.84 million for the quarter ended March 31, 2020.
• Gross profit was CAD 23.24 million in the third quarter of fiscal 2021, up 5% in US dollars but about 1% lower than in fiscal 2020 when measured in Canadian dollars, due to the significant movement in the exchange rate between the currencies.
• Gross margin for the third quarter was 66% of revenue, up slightly from 65% last year, helped by the higher proportion of services business realized in fiscal 2021, partially offset by the additional cost of sales during a period of globally tight component availability.
• Net income for the third quarter included the one-time CAD 4.74 million of expense associated with the Star2Star acquisition, resulting in a temporary net loss of CAD 2.37 million (CAD 0.021 loss per share fully diluted), compared to a net income of CAD 1.70 million (CAD 0.022 income per share fully diluted) for the equivalent quarter ended March 31, 2020.
• EBITDA was CAD 6.63 million in the third quarter, up by about 8% versus the same quarter last year in US dollars, or around 2% in Canadian dollars. EBITDA was 19% of total sales this quarter, up from about 18% in the third quarter of fiscal 2020, driven primarily by the gradually increasing fraction of recurring revenue as the services business continues to compound and the expense controls.

Top 10 Shareholders

Top-10 shareholders together holds 35.8% stake in the company, with Star2Star Holdings, LLC and Mawer Investment Management Ltd. are among the major investors, with an outstanding position of 11.37% and 7.7%, respectively.

Valuation Methodology (Illustrative): EV to Sales based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation: The company is built upon strong fundamentals, with Sangoma’s quarterly revenue in US dollars has now exceeded the revenue recorded in the last twenty-five quarters. Further, Sangoma continues to maintain a strong balance sheet, and the company is expecting FY21 financial numbers to exceed its previously announced guidance. Moreover, over the past couple of years, the company has been happily growing EBITDA by over 70% a year.

Further, the company just acquired a large American peer, which would increase its cloud-based solutions segment, widen its customer mix, improve its margin profile, and increase its recurring revenue to over 70% of revenues.

STC shares are gaining technical momentum, with stock bounced back from the lower Bollinger Band© and now traded above Middle Bollinger Band©. Further, its shares reported a Bullish engulfing on the last trading session and RSI hovering in a neutral zone with a bullish bias.

Hence, based on the above rationale and valuation, we recommend a “Speculative Buy” rating on the stock at the closing price of CAD 3.16 on September 21, 2021.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached.

Technical Analysis Summary

1-Year Price Chart (as on September 21, 2021). Source: REFINITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

*Recommendation is valid on September 22, 2021 price as well.

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