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Canadian tech darlings retain their appeal despite downdraft

Shopify Inc. and Kinaxis Inc. are two of the great emerging Canadian tech success stories, and their shares have reflected that. Kinaxis was among the top TSX performers in 2015 with a gain of nearly 150 per cent and Shopify had one of Canada's most successful IPOs last year.

This may have meant, however, that they had further to fall if there was a sector-wide downdraft in tech – such as the one we've seen over the past few weeks. Perhaps the problem with tech stocks is the fear of global recession; perhaps it's LinkedIn Corp.'s fault for dramatically scaling back its expectations for 2016.

Regardless, both Shopify and Kinaxis are down 20 per cent so far in 2016, even in the absence of any significant news or corporate announcements. That will change Wednesday, when both companies announce earnings. How the Ottawa-based companies did in their more recent quarter – and more importantly, what they may say about 2016 – could help arrest the decline, and even turn things around.

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"There's one thing we know having covered tech for many years and it's that when growth breaks – look out, particularly if it's generously valued," Richard Tse of Cormark Securities said in a recent research report. The risk telegraphed by LinkedIn and others – slowing enterprise spending, which ran counter to expectations heading into 2016 – sent high-growth tech names tumbling, he said.

Revenue estimates for companies that have reported so far in 2016 have come down by an average of 1 per cent, Mr. Tse said. "While that may not sound like much, it's more that those declines signal a slowdown in the growth momentum, which is a meaningful driver of valuation for these names."

Despite the drop-off, Mr. Tse listed Kinaxis, a "software-as-a-service" company specializing in supply-chain management, as his top pick, and he has a $55 target price, compared with Friday's close of $33.46.

He said it has a "long runway for growth," given that it has less than 5-per-cent market share in its field and he sees at least 20-per-cent growth in subscription revenue in 2016. Mr. Tse also believes the company could be a takeover target from a larger software company.

Analysts who went to Kinaxis' user conference last fall came away impressed with the company's expanding customer base. Thanos Moschopoulos of BMO Nesbitt Burns, who has an "outperform" rating and $50 target price, said in a note that he spoke to a "senior representative of a respected supply-chain advisory firm" who said "the size of customer, and size of project that we're now seeing Kinaxis being considered for, is larger than we've ever seen. … These are projects that we would have been surprised to see them being considered for just two or three years ago."

Mr. Moschopoulos heard presentations from several existing Kinaxis customers, such as Schneider Electric, Cisco, Avaya and NCR, who are extending their deployments of Kinaxis' RapidResponse software to new parts of their companies.

Paul Treiber of RBC Dominion Securities, who has an "outperform" rating and target price of $54, said in a commentary that Kinaxis is a small company ($100-million in annual sales, 300 employees) that "is building the organizational structure to scale into a world-class enterprise software company."

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"Kinaxis is gaining material traction with customers and partners, and is widely perceived as one of the leading innovators in the supply chain software market," he said. "With new investments to scale the organization, we believe it's still early days in the Kinaxis story."

The pullback in Kinaxis's shares have left it trading at an enterprise value (EV) – market capitalization plus net debt – of 17 times analysts' forecasts of EBITDA, or earnings before interest, taxes, depreciation and amortization. That may not be cheap by the overall standards of the S&P/TSX composite, but it's less expensive than Kinaxis has been since the fourth quarter of 2014, before its magical 2015 run.

It may be early days in the Kinaxis story, but it's even earlier in the tale of Shopify, which went public in May, 2015, and remains unprofitable by any measure as it spends to develop its business. Shopify started as a snowboard retailer, but founder Tobi Lutke's strength turned out to be the code for the company's website.

Now, Shopify can provide an easy-to-use online-commerce solution to small and medium-sized businesses (SMBs) for as little as $9 (U.S.) a month. "We see Shopify as the best-in-class SMB e-commerce software," said Wedbush Securities analyst Gil Luria, who has an "outperform" rating and $25 target price, versus Friday's close of $19.33 in New York. "We believe Shopify has established itself as a default platform for small businesses to set up a fully functional online store in 20 minutes, and then add capabilities and features as they scale. We believe this encouraged app developers and channel partners to connect with Shopify, which has created a network-effect moat."

According to Terry Tillman of Raymond James Financial, Shopify continues to benefit from a strong spending cycle for digital commerce platforms, and he expects Wednesday's earnings to include a "constructive outlook" from management. In the first two quarters as a public company, Mr. Tillman said, Shopify has beaten revenue estimates by more than 10 per cent, "which has helped to curtail losses at a quicker pace than expected." Mr. Tillman, who has an "outperform" rating and target price of $33, said he anticipates non-GAAP profit (that is, it may still be losing money on a final profit basis) and positive operating cash flow by the second half of 2017.

Wedbush's Mr. Luria said in a Jan. 20 report that Shopify stock, which had wiped out all its post-IPO gains, was trading at a discount to other high-growth software-as-a-service companies, with Shopify at an enterprise value of 4.8 times sales versus others at five to six times sales. His $25 price target is based on an EV/EBITDA multiple of six for Shopify, as he argues that the current price undervalues the company's revenue growth and its future profit margin expansion as it gets larger.

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These are long-term arguments for both companies, which may not matter in today's here and now. But as so much can change so soon in the tech sector, Wednesday may see both Kinaxis and Shopify shares reverse their downward trajectory. And quite possibly never look back.


Analyst consensus fourth-quarter expectations:

Kinaxis Inc.

  • Adjusted EPS: 14.3 cents (U.S.)
  • Revenue: $22.53-million
  • Average analyst price target: $52.07 (Canadian)

Shopify Inc.

  • Adjusted loss per share: 5.4 cents (U.S.)
  • Revenue: $61.16-million
  • Average analyst price target: $31.67 (U.S.)

Source: Bloomberg

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