In response to the recent share price appreciation in the technology sector, National Bank Financial analysts John Shao and Richard Tse thinks “it’s reasonable to take some money off the table” heading into quarterly earnings season given the “lofty” expectations from the Street.
“As you know, year-to-date returns across major North American Tech indices have been robust – the S&P Info Tech, NASDAQ 100 and S&P/TSX Info Tech indices are up 44 per cent, 41 per cent and 48 per cent, respectively,” they said in a research report released Monday. “If you’ve been following our research, you may recall that it was only around a month ago when we pointed to a potential “catch up trade” for small and mid-cap (SMID) tech names. To our surprise, many names in that group have moved quickly – much like the prodigious gains across mega cap Tech this year. And while we believe the early leadership in those mega cap names came via their relative growth potential combined with defensive attributes as interest shifted away from ‘growth at all cost’ – the sizeable moves across the sector have valuations back to their 10-year average, which has made it a challenging call based on the data.”
The analysts do see the potential for further upside, noting valuations have recovered from 2022 lows with the group having yet to exceed its 10-year average.
“We show on a relative basis, the relative performance of small-cap to large-cap Tech is still well below where it’s historically been,” he said. “That divergence has likely caught the interest of investors too. Since the end of April, small-cap Tech has outperformed large cap Tech by approximately 9 per cent.
“Interestingly, when it comes to Canada, while most names would likely qualify as small/mid-cap on a global basis, there’s been a similar local divergence as investors have also begun looking for the next tier of names following solid year-to-date returns in large names like Shopify (YTD up 89 per cent), OpenText (up 42 per cent), Constellation Software (up 33 per cent) and CGI (up 19 per cent), with interest already cascading in some smaller names with big moves in names like Blackline Safety (up 98 per cent YTD), Kinaxis (up 23 per cent) and Real Matters (up 62 per cent), all of which are executing within their business plans, despite a tough macro.”
For earnings season, the analysts had a cautious message for investors, declaring: “Valuations are not convincing enough to support a strong view either way for the sector.”
“Looking ahead, we see Coveo and Docebo as names that continue to execute on their business plans that have yet to mount notable moves. That said, given the macro backdrop, we’d still lean towards names with strong defensive attributes for tech exposure (e.g., recurring revenue, strong FCF generation) such as CGI, Constellation Software and OpenText,” they added.
They made a series of target price adjustments for stocks in their coverage universe:
* CGI Inc. (GIB.A-T, “outperform”) to $175 from $160. The average on the Street is $150.85.
Mr. Tse: “We believe CGI is moving back to its previous growth trajectory (both organic and inorganic) pre-COVID. Bottom line, we continue to believe CGI has more potential for outperformance given its combination of growth and defensive attributes (e.g., recurring revenue and cash flow, long-term contracts).”
* Constellation Software Inc. ( “outperform”) to $3,250 from $3,000. Average: $3,086.39.
Mr. Tse: “All in, we continue to like CSU for its defensive attributes (recurring revenue and cash flow) and heightened growth profile given the accelerated pace of capital deployment.”
* D2L Inc. (“outperform”) to $11 from $10. Average: $10.79.
Mr. Shao: “D2L has a July quarter-end and reported its FQ1 results in June. While it’s almost two months away from another earnings release, the high revenue visibility and a straightforward operating model have us believe the Company is well-positioned to report better-than-expected results care of strong sales activity in the summer months.”
* Lightspeed Commerce Inc. ( “outperform”) to US$23 from US$20. Average: US$19.50.
Mr. Tse: “We’re expecting soft FQ1 (CQ2) results from Lightspeed. While we like the Payments strategy, the staged rollout won’t be at scale until H2 which leads to some potential volatility early in the rollout.”
* Nuvei Corp. ( “outperform”) to US$50 from US$75. Average: US$56.67.
Mr. Tse: " We continue to believe Nuvei is uniquely positioned for growth in a market that’s undergoing a meaningful transformation care of the rise in digital services. Within that market, Nuvei remains a disruptive player with outsized growth relative to the sector.”
* Real Matters Inc. ( “sector perform”) to $8.50 from $6.50. Average: $6.14.
Mr. Tse: “Bottom line, with market originations appearing to be near bottom based on market data and Real Matters using the lull to advance its platform and operations (building operating leverage), we rate REAL Outperform with a revised target price.”
* Thinkific Labs Inc. ( “outperform”) to $3 from $4. Average: $4.09.
Mr. Tse: “We continue to see Thinkific as a leader in the online learning market with a competitive platform for content creators. And while the challenging macro has the potential to weigh on new paid customer growth in the short term, at 0.4 times EV/S (F23E), we think the risk-to-reward profile is favourable, particularly for a Company that’s expected to exit this fiscal year with a positive Adj. EBITDA run rate.”