While Echelon Partners analyst Rob Goff acknowledged the optics and financial impact of Converge Technology Solutions Corp.’s “huge” free cash flow outperformance in the fourth quarter of 2023 are “significant,” he cautioned “the lasting value rests on its causation.”
On Tuesday, shares of the Gatineau-based IT & Cloud Solutions provider soared over 13 per cent after it announced it expects cash flow from operations of $109-116-million for the fourth quarter and $224-231-million for full year 2023, exceeding the Street’s expectations of $23.9-million and $123.1-million, respectively.
“Management attributed a significant portion of its outperformance to reduced inventory levels that are more appropriate with supply chain bottlenecks largely addressed,” said Mr. Goff. “CTS had previously communicated that it had bulked up on inventory including the purchase of goods directly from OEMs to ensure customer deliveries. The logic behind an inventory recalibration supports its sustainability. Where equipment deliverability is not the same issue, CTS is also able to purchase from wholesalers where it can secure 75+ days of payables versus closer to 30 from OEMs. We look to see modest gains going into Q124 although they are likely to be much more modest. We do look for free cash flow in 2024 to benefit from the introduction of new policies.”
While the analyst increased his 2024 FCF from Operations estimate to $225-million from $171-million, which led him to reduce his exiting net debt calculation by $143-million (or 70 cents per share), he made only a modest 40-cent increase to his target for Converge shares to $5.80, keeping a “speculative buy” recommendation.
“Arguably, the greater financial flexibility associated with our revisions would support a more aggressive PT move,” he said. “However, we await the disclosure of full financials and further information on the 2024 outlook with the release of Q423 results on March 6th, 2024.”
“While still in the show me category, we consider CTS shares to be significantly undervalued at 7.1 times/6.6 times 2024/25 EV/EBITDA while offering an FCF yield of 17 per cent/18 per cent. We note the median 2024/25 EV/EBITDA valuations for its U.S. and European peers at 10.8 times/9.4 times and 11.1 times/9.6 times, respectively.”