CIBC NotesSoftware Valuation Monthly – March 2023
Bank Failures Lead To Software Outperformance
Our Conclusion
March was a particularly strong month for software stocks as investors
reconsidered the Fed’s approach to interest rates in the wake of the failures
of Silicon Valley Bank (SVB) and Signature Bank. March also included a
number of Q4 earnings reports, particularly within our coverage, and
commentary on the demand environment and 2023 outlook drove stock
reactions. The S&P 500 Software Index significantly outperformed the TSX
by 1,470 bps in March and ended the month up over 14%. Our coverage
also had a very strong March, with an average return of 9.2% in the month
(4.3% excluding QFOR). Only three companies posted negative returns, with
ENGH and CTS in particular pulling back in response to weak quarterly
earnings reports.
We continue to take a barbell approach to our top picks, with a mix of
defensive names (Constellation and CGI) balanced by higher-growth,
profitable SaaS names (KXS and DCBO).
Key Points
Profitable SaaS names outperformed their unprofitable peer group by
300 bps in the month, in a reversal of the first two months of the year. The
outperformance of the profitable SaaS group in March appears to be driven
by a combination of strong Q4 earnings and measures taken by select
profitable firms to further enhance their profitability. The valuations of
Canadian consolidators in our coverage universe were roughly in line with
the broader market trends, although DSGX outperformed the peer group as
its shares responded well to earnings at the start of the month, expanding
the already large valuation gap relative to the consolidator peers.
The average EV/Sales multiple across our coverage was 4.0x in March, 1.4x
below the two-year average and ~2.0x below the five-year average. DSGX is
the only name within our coverage universe trading above its five-year
average (+0.2x premium), while CGI is trading at the same level as its
two-year and five-year average. The rest of our coverage names continue to
trade at a discount to two-year and five-year averages. From a valuation
perspective, we continue to like Kinaxis and Docebo, which are trading at
2.0x and 3.8x turn discounts to their respective five-year averages.
Looking at software names on a Rule-of-40 basis, return performance was
relatively even across tiers, as the median return in Tiers 1, 2 and 4 were all
between 6%-7%. The valuation gap between Tier 1 and Tier 4 SaaS
multiples was essentially unchanged given the similarity in return profiles. In
the mature software group, Rule-of-40 scores remain less of a predictive
indicator, as the group of Tier 2 names is trading at a premium to the Tier 1
group. While less predictive, those two groups do trade at a meaningful
premium to the Tier 3 and Tier 4 names, which have traded in a relatively
consistent range over the last 15 to 18 months