EARNINGS UPDATE
NEAR-TERM CHALLENGES BUT ATTRACTIVE SETUP FOR 2025
THE TD COWEN INSIGHT
We believe the sharp pullback in the shares today is understandable but overdone, with orders delayed, not lost, and the stock already trading near historical lows and comfortably at the bottom end of the peer group. It may take some time to regain investor confidence, but we like the setup for 2025 given our expectations for a rebound in demand, strong margin expansion, and active share buybacks.
Impact: NEGATIVE
Reducing our forecasts and target. Following the negative preliminary Q3 (details here), we have reduced our F2024/25 gross profit forecasts by ~2%-3% with our Adjusted EBITDA estimates for F2024 down ~8% to C$164.2mm and F2025 down ~4% to C$191.9mm. Management indicated that it would provide updated F2024 guidance with the full Q3 release on Nov. 12.
Our lower estimates drive the decrease in our target price to C$5.00 (was C$5.50), based on 6x our F2025 Adjusted EBITDA estimate.
Broader weakness in North American hardware demand. Management indicated that the Q3 miss was not due a handful of large deals slipping but instead a broader softening in demand due to macro concerns in North America as well as some delays in data center construction resulting in deliveries being pushed out. Converge stated that the planned customer projects/orders are delayed, not canceled, including the large high-performance compute hardware deal highlighted in Q2 that remains in the pipeline. It noted that some delayed orders have shipped in early Q4.
Focus on accelerating margin improvements. With near-term growth remaining challenged, management is increasing its focus on cost optimization measures to help boost margins, including accelerating the timeline to realize benefits from its new ERP system (initially expected to begin in late Q2/F24), which should help offset the near-term weaker demand.
Strong cash flow performance expected to continue. Operating cash flow in Q3 again benefited from A/R and inventory tailwinds, leading to a 150% conversion from Adjusted EBITDA. For H2/F24, Converge is still targeting H2/F24 operating cash flow of ~75% of Adjusted EBITDA.
Share buyback activity could pick up. According to SEDI, Converge repurchased ~1.6mm shares (~C$7.2mm at C$4.35 VWAP) in Q3. There were ~17mm shares available for repurchase under Converge's NCIB at the end of Q3, which should allow it to be aggressive with its share buyback if the stock remains at current levels. We note the shares are trading near the bottom end of the historical range (5.8x EV/EBITDA - NTM) and comfortably at the bottom end of the peer group.