National Bank National Bank Financial analysts Richard Tse and John Shao see Canada’s technology sector continuing to offer “a good mix of large-cap stability (defence) and small-cap torque (offence)” heading into third-quarter earnings season.
In a research report released Thursday titled The Rate Relief Set Up, they also argue the Fed’s recent “kickstart” to an interest rate cutting cycle as well as the potential for accelerated merger and acquisition (M&A) activity “provides an added tailwind across the sector with what we believe will be an outsized benefit to growthier, smaller cap names alongside interest rate moderation given the obvious impact from lowering discount rate.”
“All in, we believe the current rate environment should provide a tailwind across our coverage group, as valuations should naturally climb as the cost of capital/discount rates compress — even so, as noted in our analysis, there are company-specific nuances to that benefit,” they said. “As far as our coverage universe, while we’ve highlighted some of the most interest rate sensitive names as carrying the most leverage (namely, Telus Digital, OpenText and Altus Group), we’d note some of those companies also happen to be facing growth challenges and as such, those names carry Sector Perform ratings. Of our Outperform coverage names, Constellation Software, Converge, Docebo, Shopify, and Tecsys, all screen well within this interest rate sensitivity analysis with what we believe to be stronger (relative) fundamental outlooks. Additionally, when considering how markets have reacted since the Fed’s September rate cut, some of our smaller Outperform names with the most ‘Upside Since Cut’ are Coveo, Thinkific and Tecsys, with 24.0 per cent, 19.9 per cent, and 10.4-per-cent return upside to the higher DCF values, respectively.”
The analysts see a “a small/mid-cap catchup trade” approaching, noting the third quarter “saw the considerably smaller Canadian tech sector (versus its U.S. peers) pick up momentum after lagging throughout most of 2024.”
“In Q3, the S&P/TSX Information Technology Index delivered a strong 11.4 peer cent (vs. its year-to-date performance of 12.9 per cent as of the end of Q3), outperforming U.S. tech rather meaningfully as the S&P 500 Information Technology Index took a breather in Q3, returning 1.4 per cent (vs. its 29.6-per-cent year-to-date),” they said. “Helping drive the Canadian outperformance were several names within our coverage — Shopify (17.2 per cent), Lightspeed (16.4 per cent) and Tecsys (15.0 per cent) all landed in the top 5 of the index’s biggest Q3 contributors.
“Looking ahead to Q4, we maintain our view on growing opportunities in small/mid-cap tech where valuation re-ratings have lagged; in addition, it’s also a group where we see building takeout prospect.”
The analysts added: “Our favoured names at the time of writing are Computer Modelling Group, Descartes, Docebo, Kinaxis, Shopify and Tecsys.”