Tech is hot: Twitter, Facebook, LinkedIn. SalesForce.com and Pandora.
Except when it’s not: Stodgy, boring, little-known – but still essential.
This describes a small group of companies in the technology distribution business – selling personal computers, networking equipment and electronic sundries to small and medium-sized businesses that don’t have their own massive information-technology departments. Dogged by the perception that the death of the PC and the emergence of cloud computing is numbering their days, they trade at price-to-earnings multiple in the low teens – if not in the single digits.
Expectations of their troubles may be overstated, however, say analysts who see solid enterprises with plenty of earnings potential, despite the low-margin environment they operate in.
Consider CDW Corp., an Illinois company that’s posted $10-billion (U.S.) in sales over the past 12 months. Analyst Brian Alexander of Raymond James & Associates Inc. calls it the “clear leading IT solutions provider in North America” due to its broad product offering, large customer base (250,000 of them), and “highly productive sales force.” As a result of its attributes, CDW has a track record of taking market share from competitors and posting profit margins and returns on capital that exceed its peers.
Mr. Alexander has an “outperform” rating and $27 price target, above recent trades around $23. He believes the share gains will continue, and with just a 5-per-cent share of a $200-billion North American IT market, CDW has “substantial” room for growth.
The trend of “cloud computing,” where computing power moves from the desktop and software to remote servers accessed via the Internet, has soured investors on many of the classic names of computing, from Microsoft Corp. and Dell Inc., to storage makers such as Seagate Technology and Western Digital Corp.
Mr. Alexander says, however, that investors are “overrating” the negative effect on CDW of the move to the cloud, as its small-to-mid-size customers will adapt gradually and reach out to CDW for help in choosing among complex cloud offerings. CDW already resells more than 200 cloud-related products from 45 different companies, he says. “We believe investors underestimate the potential for cloud to positively impact profitability in the intermediate term.”
Ingram Micro Inc. is actually larger than CDW, saleswise, by a factor of four. It has extensive international operations, with less than half of sales coming in North America. It also has much smaller margins, in part because it’s rapidly shifting its sales mix to higher volume, less profitable mobile-technology products.
Some of that margin compression can be reversed, however, with productivity improvements and cost-cutting, which management has embraced, says analyst Dylan Cathers of S&P Capital IQ. Both he and analyst Ben Reitzes of Barclays Capital also see improving gross profit margins this year from a better product mix. Recent acquisitions are adding to revenues and seem to be working well, they say.
Both analysts have “hold” ratings, with Mr. Cathers’s target price of $25 slightly above recent trades around $23. (Mr. Reitzes’s target is $21.) However, S&P Capital IQ’s “fair value” calculation, which disregards the shifting winds of the market sentiment, places a price of $28.50 on Ingram and ranks it among the 20 per cent of the “most undervalued” shares that S&P rates.
Synnex Corp. is generating perhaps the most excitement in the industry, having announced a deal to acquire International Business Machines’ customer-care business, adding $1.2-billion in revenue in a $505-million deal. The problem is that the company’s shares, already up 40 per cent on the year, have added another 25 per cent since. This is prompting analysts to place “hold” ratings on the shares not because they dislike its prospects, but because they worry about valuation.
But some of those downgrades came a little too early, they now admit. “Our [Aug. 7] downgrade, based on [our] inability to raise estimates enough to justify a higher target, was clearly wrong and/or premature, [as] evidenced by the strong operational performance and the stock’s continued rise,” says analyst Richard Kugele of Needham & Co.
Mr. Alexander, of Raymond James, calls the Synnex-IBM deal “a savvy financial move by a management team we hold in high regard,” but worries the “astounding” run in the shares mean investors are giving the company too much credit. His sum-of-the parts analysis suggests a price in the high-$50s, just below current trades around $61, and motivates his “market perform” rating.
(Synnex’s Canadian business was built from EMJ Data Systems, based in Guelph, Ont., which it purchased in 2004, and Supercom, which it bought earlier this year. Softchoice, formerly the public Canadian name in this space, went private earlier this year.)
Tech Data Corp., the cheapest of this bunch, presents a different challenge for investors: The company discovered accounting issues at its British subsidiary earlier this year, plans to restate its financials going back to 2011, and has failed to file with the U.S. Securities and Exchange Commission for much of 2013.
The misadventures mean the company’s shares have missed out on the healthy gains experienced by the company’s peers in recent months. “Investors fear where there is smoke, there is fire,” Mr. Alexander said in a research report at the time of the restatement news. “However, our gut is that this is a contained issue that will be quickly addressed through employee terminations.”
Like Mr. Alexander, S&P’s Mr. Cathers has a “hold” rating on the shares. He has a 12-month target price of $50 on the shares, right around current levels. But, as with Ingram Micro, S&P’s fair value calculation suggests more upside: $80.10 per share.
It may not be sexy, Twitter-type upside, but it would do quite nicely.