Descartes Systems Group Inc T.DSG

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[retiredcf]

Current and upside scenario targets raised to US$57.00 and US$67.00. GLTA

June 4, 2020

The Descartes Systems Group Inc. 
On the virtual road with management

Our view: We hosted Descartes’ CEO and CFO for virtual meetings with investors. While the company experienced a modest slowdown in transactions in the near term, profitability and cashflow are likely to remain resilient. Over the long term, Descartes appears likely to benefit structurally from e-commerce and the shift away from manual to electronic logistics processes. M&A is a potential catalyst for the shares. Maintain Outperform, price target to $57.

Key points:

• Long-term structural winner. The global transition to work from home may help raise adoption of Descartes’ solutions as more companies move away from manual processes for logistics to automated electronic ones. Descartes’ e-commerce solutions (10% of revenue) and trade content (est. 20% of revenue) are both seeing stronger demand amidst COVID-19-related disruptions to retail and trade/tariffs, respectively.

• The worst is likely behind the company. Revenue declined 5% in April on a run-rate basis. The slowdown primarily reflects lower transaction volumes at airlines and retailers closed under government mandates, which offset stronger demand in other segments (e-commerce, trade content). Retail reopenings and re-purposing of passenger to cargo flights may help lift volumes going forward. Management does not appear to be concerned regarding potential customer bankruptcies, given low customer concentration (largest is 1.5% of revenue) and indifference to specific channels.

• Conservative management style = potential upside to margins. Descartes is managed conservatively, focusing on recurring revenue, profitability and FCF. In light of the 5% reduction in revenue in April, Descartes implemented a 5% reduction in headcount. The restructuring saves $6-7MM costs per annum (7-8% of revenue). Eliminated positions appear to be low-hanging fruit and wouldn’t impair the future health of the company. Given likely continued operating leverage and economies of scale, we believe that upside to Descartes’ 35-40% adj. EBITDA margin target is likely over time.

• M&A is a potential catalyst for the stock. Descartes made some of its best acquisitions in 2008/2009. A repeat is possible this year, in light of COVID-19. We believe Descartes is likely to continue to deploy capital on complementary tuck-in acquisitions at mid-teens hurdle rates going forward. Larger acquisitions are possible if pricing declines later in the year.

• Maintain Outperform, raising price target from $50 to $57. Our revised $57 price target is based on 30x CY21E EV/EBITDA, up from 26x previously, given the likelihood of improved organic and acquired growth going forward. Our target multiple is justified below supply chain & fleet management peers (37x), given Descartes’ historical discount to peers. Descartes has converted 84% of adj. EBITDA into FCF over the last 5 years.