On today’s Breakouts report, there are 36 stocks on the positive breakouts list (stocks with positive price momentum), and 17 stocks are on the negative breakouts list (stocks with negative price momentum).
The technology sector is the second best performing sector in the S&P/TSX composite index year-to-date, right behind the energy sector. Discussed today is a newly listed tech stock that is rocketing higher – Softchoice Corp. (SFTC-T). On Tuesday, the share price rallied over 8 per cent. The stock may appear on the positive breakouts list in the future once more trading history is available (the stock just began trading on the Toronto Stock Exchange on May 27). Investors may want to put this small-cap tech stock on their radar screens, especially if the share price were to pullback after the remarkable rally experienced in mere weeks.
A brief outline on Softchoice is provided below that may serve as a springboard for further fundamental analysis when conducting your own due diligence.
The company
Toronto-based Softchoice is an information technology solutions provider serving customers across North America. In terms of its 2020 geographic net sales breakdown: 57 per cent stemmed from the U.S. with the balance, 43 per cent, from Canada.
In terms of its revenue breakdown, sales of Microsoft products accounted for 21 per cent of the net sales in 2020, making Microsoft the company’s largest tech partner. Cisco Systems Inc. is another major partner whose products represented 11 per cent of the company’s net sales last year.
The company has a diversified customer base with its top 10 customers accounting for roughly 10 per cent of its gross profit. Its customer composition as a percentage of gross profit is: 20 per cent small-to-mid sized businesses with annual technology capital spending budgets ranging from $500,000 to $2-million, 54 per cent commercial customers with annual tech capital spending budgets ranging between $2-million and $10-million, and 26 per cent enterprise customers who have annual technology capital spending budgets ranging from $10-million to $50-million.
There is seasonality in the company’s operations with the highest sales typically occurring in the fourth quarter.
According to Bloomberg, Birch Hill Equity Partners Management Inc. owns approximately 53 per cent of the shares outstanding.
Investment thesis
· Experienced leadership. The president and chief executive officer Vince De Palma was the president and chief executive officer of Shred-it International Inc. between Aug. 2009 and Oct. 2015. Shred-it’s revenue grew at a compound annual growth rate (CAGR) of 9 per cent between 2009 and 2014 with an organic, or internal, CAGR of 5 per cent during these years.
· Robust earnings growth forecast. Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) is anticipated to jump to between U.S. $90-million and U.S. $100-million in 2022, up from U.S. $65.5-million reported in 2020.
· Salesforce expansion. Between Dec. 2020 and Dec. 2022, management targets adding 40 to 50 AE’s (account executives), supporting sales growth.
· Recurring revenue model. Approximately 55 per cent recurring gross revenue providing earnings visibility.
· Rotation into growth stocks.
Financial results
Financial results are reported in U.S. dollars.
For the three months ending March 31, the company reported net sales of $233-million, up 7 per cent year-over- year from $217-million reported during the same period last year. Gross profits were $63-million, up from $57-million reported in the prior year. Adjusted EBITDA was $10.5-million, up from $8.5-million reported last year. The company reported adjusted earnings per share of 6 cents, up from 3 cents reported during the same period last year.
In 2020, the company reported net sales of $837-million, down from $954-million reported in 2019. Gross profit came in at $238-million, down from $253-million in the prior year. Adjusted EBITDA was $65.5-million, up from $62.5-million reported in 2019. Adjusted earnings per share was 64 cents, up from 50 cents reported in the previous year. Adjusted free cash flow conversion was 88 per cent, up from 85 per cent reported in 2019.
Looking out to 2022, management has provided the following guidance: Gross profit of over $300-million (growth from higher market penetration, growth in the company’s salesforce as well as higher productivity within its salesforce), adjusted EBITDA of between $90-million and $100-million, and adjusted free cash flow conversion increasing to approximately 90 per cent.
Dividend policy
The inaugural dividend will be paid in Oct. to shareholders of record on Sept. 30 and will total approximately 9.3 cents per share.
Going forward, Softchoice plans to pay its shareholders a quarterly dividend of 7 cents per share or 28 cents per share yearly, equating to a current annualized yield of 1.1 per cent.
Analysts’ recommendations
Currently, two analysts have initiated coverage on Softchoice - both with buy recommendations.
The two firms providing research coverage on the company are ATB Capital Markets and TD Securities.
Other firms in the underwriting syndicate included Goldman Sachs Canada, RBC Capital Markets, National Bank Financial, CIBC Capital Markets, Scotiabank, BMO Capital Markets, Cormark Securities, Laurentian Bank Securities, Raymond James and INFOR Financial Inc. Consequently, I would not be surprised to see analysts from several of these firms initiating coverage on the company in the months ahead.
Financial forecasts
According to Refinitiv, Martin Toner, the analyst at ATB Capital Markets, is forecasting gross profit of U.S. $267-million in 2021, rising to U.S. $300-million in 2022. The analyst anticipates EBITDA will come in at U.S. $63-million in 2021 and U.S. $84-million in 2022. Meanwhile, David Kwan, the analyst at TD Securities, anticipates EBITDA will be Cdn. $68.2-million in 2021 jumping to Cdn. $97.7-million in 2022.
Valuation
According to Refinitiv, Softchoice is trading at an enterprise value-to-EBITDA multiple of 15.9 times the consensus 2022 estimate.
The average one-year target price is $28 Canadian, suggesting the stock price has 13 per cent upside potential. Both analysts covering the company have identical target prices of $28.
In comparison, industry peer CGI Inc. (GIB-A-T) is trading at an EV/EBITDA multiple of 12 times the consensus 2022 estimate.
Chart watch
Technical analysis is limited due to the stock’s brief trading history.
The stock just began trading on the Toronto Stock Exchange on May 27. The share price is already up 24 per cent from its initial public offering price of $20.
This small-cap stock with a market capitalization of $1.45-billion is thinly traded. As a result, the share price can be volatile. To illustrate, on July 6, the stock price jumped 8.4 per cent with over 52,000 shares traded.
Please note that this report is not an investment recommendation. The Breakouts file is a technical analysis screen intended to identify companies that are technically breaking out. In addition, this report highlights a company’s dividend policy, analysts’ recommendations, financial forecasts, and provides a brief technical analysis for a security to provide readers with more information.
If a stock appears on the positive breakouts list, this indicates positive price momentum, and that a company may be worthwhile for investors to look at the fundamentals in order to determine if the recent price strength is warranted and will continue. If a security appears on the negative breakouts list, this indicates negative price momentum, and may be indicative of either deteriorating fundamentals or perhaps indicates a buying opportunity.
Securities screened are from the S&P/TSX composite index, the S&P/TSX Small Cap index, as well as Canadian small cap stocks outside of these indices that have a minimum market capitalization of $200-million.
A technical analysis screen does not replace fundamental analysis, but can help identify companies worth having a closer look at.
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Jennifer Dowty