Constellation Software Inc. (TSX: CSU), is engaged in the development, installation, and customization of software. They acquire, manages, and builds vertical market software (VMS) businesses. The Company is catering its services to both segments, the public sector, and the private sector.

Key highlights

• Degrowth in net income: In FY2021, the company’s revenue grew 29% to USD 5,106 million compared to USD 3,969 million in 2020, despite this its net income fell heavily to USD 169 million compared to USD 436 million in pcp. This depicts the company is facing cost pressure.

• Fading Free cash flows: In the reported period of FY 2021, the company’s Free cash flow available to shareholders witnessed a degrowth at USD 883 million against USD 989 million in pcp.

• Higher cash conversion period: The group reported a higher cash conversion period of 169 days in FY21, as compared to the industry median of only 35.3 days. This indicates that the company takes a higher time to convert its investments to cash flows. Continuation of the above trend would dampen the company’s overall performance.

• Heavily leveraged: The company’s debt to equity ratio at the end FY21, stood at 1.17x, which is too high against the industry median of 0.19x. It is also rising on sequential basis. Additionally, its % long term debt to Total Capital stood at 40.0% against the industry median of 13.8%. These factors imply higher balance sheet risks.

• Weak liquidity profile: In FY 2021, the company's current ratio stood at 0.74x compared to the industry median of 1.86x. This lower ratio against the industry indicates that the company's short-term obligations are growing faster than its resources to cover them, which is not a good indication.

Stock recommendation

Despite higher revenue the company failed to achieve improved net profits which witnessed a heavy degrowth, depicts the company is facing cost pressure. Moreover, it also has a prolonged Cash Cycle (Days), which may create a difficulty for the company to have enough cash on hand to meet their financial obligations. Additionally, the stock is trading at premium valuations on multiple parameters, which also raises a concern for safely in an investors mind.

Therefore, based on the above rationale and valuation, we recommend a “Watch” rating on the stock at the last closing price of CAD 2,229.76 on April 13, 2021. Additionally, the markets are trading in a highly volatile zone currently due to certain macro-economic issues and geopolitical tensions prevailing. Therefore, it is prudent to follow a cautious approach while investing.

One-Year Technical Price Chart (as on April 13, 2022). Source: REFINITIV, Analysis by Kalkine Group

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