Echelon Partners analyst Rob Goff thinks “strong demand and financial execution [have brought] significant deleveraging while building investor confidence” for Converge Technology Solutions Corp.
Before the bell on Wednesday, the Toronto-based company reported revenue of $651.1-million for its fourth quarter of fiscal 2023, falling short of the estimates of both Mr. Goff ($718-million) and the Street ($709-million). However, EBITDA of $46.5-million came in higher than anticipated ($45-million and $46-million, respectively).
“Delivering Q4 results to guidance and above peer performance levels supports positive revaluation considerations where CTS despite its 80-per-cent six-month recovery remains discounted to slower growth peers,” said the analyst. “The introduction of Q124 together with 2024 guidance should increase confidence while nudging the consensus EBITDA forecast upwards. We are particularly impressed with the full-year EBITDA guidance in a year where CTS is investing in seasoned talent to strengthen its sales and technical capabilities.”
Mr. Goff expressed “higher confidence” in Converge, raising his projections for both fiscal 2024 and 2025. He predicts the firm’s focus will be “moving to gross profits where accounting requirements swing product sales about freight delivery language within contract.”
“CTS noted efforts to further improve working capital management where the easing of supply constraints allows it to carry reduced inventory levels (aka more in line with pre pandemic levels),” he said. “Furthermore, changes to commission structures taking effect by July 1st are expected to improve A/R cycles. CTS looks for integration efficiencies to offset its moves to hire sales and talent. The outlook calls for continued strong services growth following on the 20 per cent recorded for the quarter while the product sales declined of 3.3 per cent on the quarter should see H224 growth aided by the roll out of a Windows upgrade cycle. We note CTS services growth compares with 6.2 per cent and negative 1 per cent for Softchoice (SFTC-TSX, not rated) and CDW (CDW-NASDAQ, NR) on their most recent quarters. Management revised its prior FCF from Operations target of 70-per-cent conversion to 75 per cent with the quarter. The 5-per-cent swing would represent roughly $10-million or $0.05 per share annually.”
Reiterating a “sector perform” recommendation for Converge shares, Mr. Goff increased his target to $6.25 from $5.80. The average is $6.14.
“While working its way out of the show me category, we consider CTS shares to be significantly undervalued at 6.3 times/5.7 times 2024/25 EV/EBITDA while offering an FCF yield of 16 per cent/17 per cent,” he said. “We note the median 2024/25 EV/EBITDA valuations for its U.S. and European peers at 11.2 times/10.2 times and 10.4 times/7.6 times, respectively.”
Elsewhere, others adjustments include:
* Desjardins Securities’ Jerome Dubreuil to $7 from $6 with a “buy” rating.
“CTS reported decent results in an overall challenging IT market —which deserves credit, in our view, since the company was previously perceived to have high exposure to macroeconomic headwinds. On the call, management confirmed that M&A was not around the corner despite the company’s rapid deleveraging, which signals that it is still seeing material organic growth opportunities. We see CTS’s improving cash flow management and better earnings visibility derisking the stock.
* Eight Capital’s Christian Sgro to $9 from $7 with a “buy” rating.
“The financials and outlook support our view that Converge’s historical, aggressive consolidation strategy has translated into above-industry organic performance. Converge acquired decades of technical experience with important geographic coverage, now unified under a leading end-to-end offering and full suite of capabilities. Continued execution on cash generation and de-leveraging through the year will unlock shareholder value, in our view, as the valuation discount to peers narrows,” said Mr. Sgro.
* Raymond James’ Steven Li to $6.50 from $5.50 with an “outperform” rating.
“Management’s confidence in driving stronger FCF conversion, expanding margin from efficiency, and accelerating investments in organic growth are clearly positive developments for the story and should further support the stock price, despite the softness in the German business,” said Mr. Li.