Computer Modelling Group Ltd (TSX: CMG) is a Canada-based is a software company that produces reservoir simulation software for the oil and gas industry.

Positives:

• The group has industry-leading margin profile, and maintained consistency over the last five years, with EBITDA margin above 40%, operating margin above 35% over the past five years and Net margin above 25% over the past five years. The group has delivered ROE above 35% over the past five years.
• LTM ROCE of 36.5% gigantically higher than the Weighted Average Cost of Capital (WACC) of 9.5%.
• The stock is offering a lucrative dividend yield of 3.86%, higher than the TSX Composite Index’s dividend yield of 3.6% and Canada 10-year Bond Yield of 0.55%. Also, the stock is offering a free cash flow yield of 2%.
• Insider Buying: 5 insiders have increased their ownership position in the company, including Chief Financial Officer - Sandra Balic

Negatives:

• Relatively higher debt contribution in the company’s balance sheet, with debt/equity ratio of 1.10x, higher than the industry average of 0.31x; however, maintained a solid interest coverage ratio of ~15x, which implies low balance sheet risks.
• Insider Selling - Group’s Vice President - Kenneth M. Dedeluk has reduced its stake by more than 90% in 2020.

1QFY21 Financial Highlights

• Revenue lowered by 8% on a YoY basis due to a decrease in software license revenue, which was partially offset by an increase in professional services revenue.
• The United States (representing 29% of total software license revenue) experienced a 14% decrease in annuity/maintenance license revenue during the three months ended June 30, 2020, compared to the same period of the previous fiscal year.
• The Eastern Hemisphere (representing 39% of total software license revenue) experienced an annual increase of 11% in annuity/maintenance license revenue during the period due to a new multi-year contract with a customer and increased licensing by existing customers.
• Direct employee cost increased due to higher headcount, and other corporate costs decreased by 16% on a YoY basis.
• EBITDA was down by 17% compared to the first quarter of the previous fiscal year, while, EBITDA margin stood at 41% compared to 45% in the year-over period.
• The group has ended the quarter with CAD 51.2 million of cash and no debt and realized free cash flow per share of CAD 0.05 during the quarter.
• As on August 10, 2020, the Board declared a dividend of 0.05 per share.

Technical Indicators

Source: Refinitiv (Thomson Reuters)

At the last traded price of CAD 5.18, its shares traded slightly above its short-term support level of 50-day SMA; however, traded below its long-term support level of 200-day SMA. A strong breakout above its 200-day SMA of CAD 5.47 would bring the in bullish territory.  The 14-day RSI is hovering in a neutral zone. 

Risks: Due to high dependency on oil and gas clients, adverse effect on crude oil demand can hit revenues of the company. Lower demand for crude oil would result in lower drilling activity by the oil manufacturers resulting in lower budget allocation for the software and maintenance purposes.

Valuation Methodology (Illustrative): Relative Valuation

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters)

Stock Recommendation: Despite a challenging market condition and mixed performance of CMG shares, the stock has significantly outperformed its peers in the last one month, three months and one year. Also, from the years bottom of CAD 3.42 (on March 30th, 2020), its shares have recorded sharp recovery, and at the last traded price, its share was up ~ 52%.

The company is focused on ensuring the resilience of its business by adjusting its cost structure. It has taken various cost reduction measures and is protecting liquidity and seems to be well-positioned to deal with these uncertain times. The group has delivered a decent result and took prudent measures to manage cost amid the challenging time. However, the group is serving the oil & gas industry, which is going through a pain owing to lower demand in the past few months. Though the demand recovery is coming, it is still not close to the pre-pandemic level.

Therefore, considering the above-mentioned facts, we have given a “Speculative Buy” rating at the closing price of CAD 5.18 on September 17, 2020.

Disclaimer

The advice given by Kalkine Canada Advisory Services Inc. and provided on this website is general information only and it does not take into account your investment objectives, financial situation and the particular needs of any particular person. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it. You should seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice. Not all investments are appropriate for all people. The website www.kalkine.ca is published by Kalkine Canada Advisory Services Inc. The link to our Terms & Conditions has been provided please go through them. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine do not hold positions in any of the stocks covered on the website. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations later.