Desjardins Securities analyst Jerome Dubreuil thinks the fourth quarter of fiscal 2023 could be “the bottom” for Canadian information technology service providers, emphasizing “growth is decelerating but forward guidance is becoming more optimistic.”
“Global peers’ results so far this earnings season signal further challenges in revenue growth for IT services companies under our coverage given the ongoing challenges of prolonged sales cycles and difficulties in converting pipelines into actual sales,” he said. “Despite this, large-cap IT services companies are breaking 52-week highs, likely due to the general expectation among companies that have reported thus far that revenue growth has now bottomed. We expect companies to continue discussing their respective generative AI monetization opportunities as investors still assess the size of this opportunity. We continue to like the sector’s attractive attributes and we find current valuations reasonable.”
In a report released Tuesday, Mr. Dubreuil said investors are currently “paying for solid business models.”
“The largest global peers in the IT services sector currently trade at 0.5 times below the sector’s EV/FY2 EBITDA spread vs the S&P 500,” he said. “Amid uncertain macroeconomic conditions, we like the sector’s defensive attributes as companies seeking cost optimization often rely on technology investments. Moreover, the sector’s nimble business models and robust free cash flow generation add to its attractiveness. We believe an improvement in companies’ growth prospects could serve as a key catalyst for the sector’s valuation to revert to its historical average spread with the S&P 500.”
He named Converge Technology Solutions Corp. as his “top pick” ahead of earnings season.
“The stock has risen more than 20 per cent since 3Q earnings (vs 7 per cent for the S&P/TSX Index), and we believe the company is on the right track in terms of asset integration initiatives and earnings visibility,” he said.
Maintaining a “buy” recommendation, Mr. Dubreuil raised his target for the Toronto-based company by $1 to $6. The average is $5.85.
He also raised his target for CGI Inc. (“buy”) to $163 from $154. The average is $152.64.
“Our forecast is now slightly below the Street’s estimate as we believe organic growth should continue to slow in light of recent results from global peers,” he said. “However, GIB’s relatively small exposure to consulting (which is more discretionary), large exposure to the government vertical and recent strong bookings should help protect its results from the industry-wide headwinds.”
Mr. Dubreuil maintained his targets for these stocks:
* Quisitive Technology Solutions Inc. (“buy”) at 70 cents. Average: 72 cents.
“Investors’ focus is likely to remain on strategic initiatives as synergies between the payments and cloud businesses are not as obvious following the PayIQ divestiture. We believe QUIS represents a good 2024 takeout candidate given how markets consistently undervalue the name,” he said.
* Alithya Group Inc. ( “buy”) at $2.70. Average: $2.66.
“We believe more patience is required before we see a material improvement in the company’s top line given we have not noticed an improvement in spending patterns from the financial services sector, which has been a source of challenges for ALYA recently. However, recent focus on efficiency should help profitability,” he said.
Elsewhere, Stifel’s Suthan Sukumar hiked his CGI target to $170 from $160 with a “buy” rating ahead of its Wednesday earnings release.
“Discretionary spend pressures and slower client decisions remain a sector headwind, driving limited visibility on growth, keeping us cautious near-term, while recent bookings momentum and record backlog continues to signal H2-weighted strength, keeping us constructive on the longer-term picture,” he said. “As such, we are not expecting any surprises with the print. Our estimates sit generally in-line with the Street, reflecting expectations for moderating growth alongside further margin expansion as CGI executes on their new cost optimization program. We expect continued bookings performance reflecting CGI’s differentiated positioning with end-to-end capabilities, particularly in managed services and IP, which cater well to shifting client priorities to cost takeouts, boding well for further share gains and stronger growth prospects ahead, in our view, with upside from an improving M&A environment.”