Q2/F22 IT Solution Provider Preview: Demand Remains Solid
Robust Software/Cloud Demand Should Mitigate Hardware Challenges
We believe continued strong demand for software and cloud solutions should be a key growth driver this quarter for IT Solution Providers including Softchoice and Converge. Although Microsoft's Q4/F22 results fell short of expectations (in part due to the stronger US$), growth remains strong across key business segments sold through the channel (details here). Meanwhile, cloud revenue should benefit from continued robust cloud migration activity, with the Big Three cloud vendors (Amazon, Microsoft, Google) delivering healthy y/y growth in cloud revenue in the mid-30% to mid-40% range this quarter.
However, we believe hardware revenues will be challenged again this quarter due to continued IT supply chain issues highlighted by the lockdowns in China early in the quarter in particular. These challenges along with some tougher y/y comps provide a more difficult growth outlook for hardware, as evidenced by the preliminary estimates from Gartner and IDC that suggests that PC shipments in Q2 fell by double digits y/y.
Converge (CTS-T: HOLD; C$8.50 target) - We are expecting continued strong acquisition-driven revenue growth with organic growth tempered by ongoing IT supply chain challenges that we believe may result in little to no reduction in its near $0.5B backlog. Although we do not believe FX should have a material impact on revenue this quarter (as the stronger US$ should more than offset the weaker euro vs. the C$), the continued euro weakness into Q3 could provide a modest revenue headwind in the coming quarters.
We expect margins to materially improve vs. last quarter toward more normal levels, given the significant drag to gross margins from large volume hardware sales to the Canadian government in Q1/F22.
Softchoice (SFTC-T: BUY; C$32.00 target) - Q2 is typically a seasonally stronger quarter for Softchoice, given that it coincides with Microsoft's fiscal year-end, and we expect the same to play out again this year. We expect growth and margins to progressively improve throughout the year, as the company increasingly realizes the benefits from Project Monarch as well as strong customer demand that helped lead to a surge in hiring last quarter. As a reminder, management remains confident in achieving its F2022 outlook.
We also note that Softchoice's share buyback activity remained strong in Q2/ F22. Despite its stock being up >10% YTD, significantly outperforming the broader markets (down ~10-20%) and its ITSP peers (down >20% on average), Softchoice remains very active with its NCIB, as it bought back ~713k shares in Q2/F22 (~1.2% of shares outstanding) for >$15mm. Meanwhile, last week, Converge announced plans for a NCIB to buyback up to 5% of its shares (details here).