Constellation Software Inc

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:

• Increase in Free cash flows:In FY2020, the company increased its cash flows from operations by USD 419 million or 55% to USD 1186 million compared to USD 767 million in the previous corresponding period. Free cash flow available to shareholders also increased by USD 399 million or 68% to USD 989 million compared to USD 590 million in pcp.

Source: Company

• Riding high on the acquisition: Recently, the group's subsidiary acquired "SSP Limited", a global supplier of technology systems and software for the property and casualty insurance industry. We believe this acquisition would enhance the Company's presence in the new geography and augurs well for the overall revenue growth. 

• Better than industry margin profile:The Company outperformed the industry margin profile, which is a key positive. In FY 2020, the group reported EBITDA margin, operating margin, and a net margin of 30.0%, 18.0% and 11.0%, respectively, higher than the industry median of 9.7%, 0.9% and (4.5)%. 

• Healthy Liquidity:On the back of healthy operations, the company managed to increase its cash balance by USD 442 million to USD 758 million on December 31, 2020, compared to USD 316 million at December 31, 2019.

• Dividend distribution: The company declared a dividend of USD 1.00 per share payable on April 9, 2021 to all common shareholders of record at close of business on March 16, 2021.  

Financial overview of FY2020 (In millions of U.S. dollars)

Source: Company

• For the year 2020, total revenues posted by the company stood at USD 3,969 million, increased by 14%, or USD 479 million, compared to USD 3,490 million in FY2019, primarily due to growth from acquisitions, partially offset by negative organic growth of 3%.

• Total expenses reported by the group increased 9%, to USD3,246 million, compared to USD2,979 million in FY 2019. Expenses as a percentage of total revenue increased and stood at 82% in 2020, compared to 80% in 2019, due to rise in staff expense.

• Based on the rise in revenue numbers as well as higher income before tax in the reported period, the Company posted net income of USD436 million compared to net income of USD333 million in the previous corresponding period. 

Risks associated with investment

A further breakout of covid-19 might result in cancellation by individual customers of their ongoing software maintenance contracts and the suspension or revocation of new software purchases. The pandemic may also harm many of the customers, including their ability to fulfil ongoing payment obligations to the company, which could increase the company’s bad-debt exposure. Another critical risk involves fluctuation in foreign currency compared to USD. 

Valuation Methodology (Illustrative): Price to Cash flows

All forecasted figures and peers have been taken from Thomson Reuters 

Stock recommendation

In FY 2020, the company posted a robust set of numbers, with ample liquidity in hand along with positive free cash flow available to shareholders of USD 989 million, which allows the company to expand their wing in new territories through acquisitions, which the company is doing at their best. Moreover, the company is outperforming the industry margin profile on many fronts, which is a key positive. Therefore, based on the above rationale and valuation, we recommend a “Hold” rating at the closing price of CAD 1728.40 on March 29, 2021.  We have considered Intuit Inc, Accenture PLC, Enghouse Systems Ltd. as the peer group for the comparison.

1-Year Price Chart (as on March 29, 2021). Source: Refinitiv (Thomson Reuters)

Descartes Systems Group

Descartes Systems Group (TSX: DSG) is the global leader which provides on-demand, software-as-a-service solutions focused on improving the productivity, performance and security of logistics-intensive businesses. The software service enables users of the shipping industry to communicate with each other.

Key Updates:

• Acquisition of QuestaWeb: Recently, the group reported the acquisition of QuestaWeb, a leading provider of foreign trade zone and customs compliance solutions, at a price consideration of USD 36 million. The above acquisition would help the company’s clients to manage the entire foreign trade zone process, coupled with lowering duties, fees and taxes while remaining compliant with CBP regulations.  

• Addition of new client: Recently, an Ontario-based Universal Logistics Inc., a freight forwarding and customs brokerage services provider reported the usage the Descartes Canadian Customs Brokerage™ solution, which has enhanced customer satisfaction and improves operational effectiveness through automation of labor-intensive customs declarations processes. The above services allow timesaving by completing multi-page commercial invoices within 10 minutes that takes hours to complete. We believe this type of enhanced features is likely to drive the company’s overall product presence, as most of the companies are leaning towards cost-efficient strategies to support their overall margin.

FY21 Financial Highlight:

• DSG announced its full-year result, wherein the company posted revenue of USD 348.664 million, higher than USD 325.791 million in FY20.
• Gross margin stood higher at USD 258.754 million v/s USD 240.070 million in FY20, thanks to the higher revenue, partially offset by a higher cost of revenues (USD 89.910 million v/s USD 85.721 million in pcp).
• The year was marked by a slide in sales and marketing costs, higher R&D and general and administrative expense, coupled with marginal increase in the amortization expense. Income from operations stood higher at USD 71.396 million v/s USD 52.258 million in FY20.
• Net income stood higher at USD 52.100 million v/s USD 36.997 million a year ago.
• The group reported an increase in cash balance at USD 133.661 million from USD 44.403 million in FY20.

FY21 Income Statement Highlights (Source: Company Report)

Risk: The products of the company require constant research and development in order to stay afloat within the industry. Moreover, the arrival of new players with a better value proposition may lead to price competition, which could act as a drag on the company’s margins.

Valuation Methodology (Illustrative): P/CF based valuation

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation:

The group reported strong growth in adjusted EBITDA to USD 142 million in FY21, v/s USD 122.6 million in FY20, which is impressive. Moreover, cash from operations stood significantly higher at USD 131.23 million v/s USD 104.252 million in FY20. The above improvement denotes strong earnings coupled with impressive cash flows, despite a challenging economic time, which is encouraging. We have valued the stock using the price to CF based relative valuation method and have arrived at a single-digit upside (in percentage terms). For the said purposes, we have considered peers like Upland Software Inc, Enghouse Systems Ltd etc. Considering the aforesaid facts, we recommend a ‘Hold’ rating on the stock at the closing market price of CAD 74.91 on March 29, 2021.

One-Year Price Chart (as on March 29, 2021). Source: Refinitiv (Thomson Reuters)

Disclaimer

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