Softchoice (TSX: SFTC)
Sector Perform, C$27.00 price target
We expect Softchoice to report Q1 gross profit in line with consensus and reiterate FY22 guidance. Near-term visibility is high, since the IT spending environment remains healthy and efficiency improvements from Project Monarch are likely. Maintain Sector Perform, as valuation appears to fairly reflect Softchoice’s near-term growth and cashflows.
Softchoice to report Q1 results on May 12. Softchoice is reporting Q1/FY22 (Mar-qtr) results on May 12, before market open. Conference call is scheduled for 8:30 a.m. ET. Dial-in: (888) 664-6392 or (416) 764-8659, confirmation #47729546.
Anticipate Q1 gross profit up 10% Y/Y, in line with consensus. Due to gross vs. net accounting and the mix shift towards Software & Cloud, gross profit is more relevant than gross revenue. We forecast Q1 gross profit to rise 10% Y/Y to $70MM, in line with consensus ($70MM). We believe the demand environment for software and technology spending remained healthy through Q1. Our outlook calls for gross revenue to decline 8% Y/Y to $214MM, below consensus at $233MM. We assume the ongoing mix-shift to Software & Cloud continues Q1.
Forecast adj. EBITDA up 46% Y/Y, slightly below consensus. We anticipate non-GAAP opex (excluding stock-based comp) to remain flat Y/Y, as we expect efficiency benefits from Project Monarch to offset new investments (i.e. sales force additions). As a result, the Y/Y increase in gross profit (+$7MM) largely flows through to adj. EBITDA. We expect adj. EBITDA up 46% Y/Y to $15.3MM Q1, which is slightly below consensus at $17.3MM. Consensus appears to reflect lower opex than our estimates. We forecast adj. EBITDA margins to increase 270bps Y/Y from 4.5% Q1/FY21 on improvements in productivity. Our $0.17 adj. EPS estimate is slightly above consensus at $0.15, likely due to differences in tax.
Following significant working capital tailwinds Q4 ($36MM Q/Q), we expect Q1 operating cashflow to fall to $4MM from $48MM Q4. Softchoice typically sees working capital outflows in Q1. After nominal capex of $0.5MM Q1, our model calls for free cashflow of $3MM, down 47% Y/Y and from $47MM Q4. As a result, we expect net debt of $89MM ($1.40/share) Q1, effectively flat with $86MM ($1.36/share) Q4.
Expect Softchoice to reiterate FY22 guidance. We believe Softchoice is likely to reiterate FY22 guidance for ~$320MM gross profit (implies 12% Y/Y growth), ~$96MM adj. EBITDA (39% Y/Y growth), and ~$86MM FCF (90% conversion). When provided, Softchoice indicated the demand environment is strong and it is benefitting from improved efficiencies (Project Monarch forecast to add $25MM to FY22 adj. EBITDA), which help offset new sales investments.
Read-throughs from key partners. The best indicator of Softchoice’s near-term quarterly momentum are results from Softchoice’s two largest partner relationships, Microsoft (22% of FY21 net revenue) and Cisco (11% of FY21 net revenue).
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Cisco delivers strong Q2, expects supply chain improvements in 2H/CY22. On Feb 16, Cisco reported Q2/FY22 (Jan-qtr) revenue increased 6% Y/Y to $12.7B, slightly ahead consensus at $12.6B. Cisco guided to Q3 revenue of $13.2-13.4B (3-5% Y/Y), above consensus ($13.2B). Management cited strong demand across its entire portfolio, despite supply constraints. Cisco reiterated FY22 revenue growth guidance of 6-7%, which includes a $14B hardware backlog that is expected to unwind over coming quarters.
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Microsoft is reporting Q3/FY22 on April 26. Microsoft will publish Q3/FY22 (Mar-qtr) results after the close of the market on Tuesday, April 26 and Microsoft’s results are likely to influence investor sentiment on Softchoice.
Canadian technology spend increases through January. Based on the most recent data from Statistics Canada, the GDP of the ICT services sector increased 6% Y/Y in January (4% on a 2- year CAGR basis), up slightly from the 3-month period ended Dec 2021 average of 5% (3% 2- year CAGR). The computer systems design and related services sector rose 12% Y/Y in January (7% 2-year CAGR), up from the 3-month period ended Dec 2021 avg. of 9% (5% 2-year CAGR).
Maintain Sector Perform. Our Sector Perform thesis reflects our view that Softchoice has already undergone a strategic and operational transformation to better address the cloud and improve profitability. Our outlook calls for healthy revenue, adj. EBITDA and FCF growth between FY21 and FY23e. However, with growth and margin expectations reset and valuation near peers, we believe the shares are currently fairly valued.