Nick Agostino, the diversified technology analyst from Laurentian Bank Securities, discussed his stock recommendations with The Globe and Mail, highlighting three stocks that he believes have upside potential: Solium Capital Inc., Kinaxis Inc. and Savaria Corp. Below are excerpts from our conversation.
Is there a common denominator in your three stock recommendations?
The attractiveness [to these companies] for me is solid industry fundamentals, good management teams, and operating leverage [characterized by margin expansion and cash flow growth]. I think this is evident in two of the stocks and in the case of Solium, they are going through an investment phase so we expect that operating leverage will once again shine through as they move through the investment phase as we get into 2019.
Let's begin the conversation by discussing a strong performer in 2017, Solium Capital.
It is a SaaS company, software-as-a-service, and is the only company that has a global platform for ESOP [employee stock ownership plan] management, which is stock option planning…Their customer base is global, [with operations] throughout North America, into Europe, and right down into Australian, and they are looking at opportunities in Asia.
They recently raised money in a bought deal financing, is this to expand into different geographies?
They have about $93-million (U.S.) on their balance sheet, no debt, and I would say that those dollars are for [mergers and acquisitions], geographic expansion as you alluded to. I would [highlight] Europe, just to gain a stronghold on the European market…They have already indicated that they would be open to do an acquisition that would essentially double the company. They have historically done a series of smaller, tuck-in acquisitions.
Your target price is $12.75, what will drive the stock price to that level?
They are proving out their thesis and proving out their ability to, longer-term, corner the market opportunity... Recently, they announced Morgan Stanley and UBS as white-label partners. White-label refers to Solium providing the technology solution with the clients putting their own brand name on it, hence the "white-label". That, to me, was validation of the thesis because now when they onboard Morgan Stanley and UBS [customers], they are bringing along sizeable revenue opportunities and very reputable customers. I think [there is a] snowball effect that comes as a result of those two wins. We think that not only does it help generate other strategic wins with other large U.S. banks, that historically had an in-house solution and are now looking for a better solution so they turn to Solium, we think there are more opportunities of that nature coming, but we also think that as they onboard these large enterprise customers, and in a lot of cases they are blue-chip customers of those big banks, we think that through word of mouth they [will be] able to get more and more large enterprise customers onboarded.
When will investors see traction from these contract wins?
The way the contracts are structured, in aggregate, our estimate is that they are worth $26-million to $28-million (U.S.) annually in revenue. To get to that number, which we think they will reach by mid-2019, they have to go out and onboard all of Morgan Stanley's customers and have to go and onboard all of UBS's customers. Before they could do that, they had to go out and spend money in both cases, to hire people to help on two fronts, to add incremental product features that were requested as part of those contracts, as well as to hire people to help with the onboarding process. That process of hiring the people and implementation began in second quarter of last year, so in the second and third quarters, margins have been going down because they haven't recognized the full revenue opportunity yet but they have started to realize the cost component. We think the cost component peaks out in the first quarter of this year…..As we move through 2018 and into early 2019, they will continue to onboard those customers, they will start to recognize revenue from them, so costs will start to plateau as of the first quarter of this year but the revenue growth will start to accelerate as more and more of these customers are onboarded….We expect revenue to accelerate through 2018 and into 2019.
Your target price is $12.75, which is based on a blended 2018/2019 EV/sales [enterprise value-to-sales] multiple, why do you believe that is a fair valuation?
I used to look at this company as an EV/EBITDA story until they got these opportunity so now I have switched my valuation in the near-term to a EV/sales multiple because that is where the growth is going to come through in the interim. Secondly, when I benchmark them against other SaaS companies…those guys trade in the 3.5 to 4 times or probably even north of that so I think 3.5, as far as SaaS companies are concerned, is a very fair multiple. As far as their comparables are concerned, we are using a little bit of a discount because of the size factor; however, should they announce another strategic white-label win, we could see further multiple expansion, something in the 4 to 4.5 times range. To me, this [stock price] could be $15 to $20.
How much of the company's revenues are recurring?
About 95 per cent.
In summary, the catalysts are?
An acquisition, a white-label agreement, and a snowballed effect from large enterprises signing on.
Kinaxis is the second company that you want to highlight, a software provider of supply chain planning.
Once again, another SaaS company with a high recurring revenue model, very solid EBITDA [earnings before interest, taxes, depreciation and amortization] margins reported with [margin] expansion opportunity…[Kinaxis has] a good management team and solid industry fundamentals. Their subscription growth rate as of last quarter was 24 per cent [year-over-year].
Management is guiding to between 22 per cent and 23 per cent subscription revenue growth.
I would say that they are being conservative.
What is driving that growth and is it sustainable?
Not only do I think it's sustainable, I think we could see an acceleration…We are now starting to see the system integrators (SIs) that the company signed on with, so Accenture, Deloitte, Bain…We are starting to see those guys starting to deliver new contract opportunities. The Toyota win announced on January 23, 2018 is a good example. They are the sales force if you will. They are now starting to get the business driven to them by these large SIs… They announced Accenture over two years ago and it typically takes 12 to 18 months for contracts to come to fruition. In the case of Accenture, we are now at that maturity stage, and the company is calling out that the biggest driver of their new wins is coming as a result of their system integrator partners. That is one variable, the other variable is the fact that they are starting to go into more and more verticals.
These guys (SIs) have better C-suite relationships [with CEOs, CFOs and COOs]. They are tapping into their C-suite relationships to drive sales…The growth is coming from the system integrators, the growth is coming from moving into new verticals, and the growth is coming from an expanding addressable market.
You are forecasting revenue of $160.7-million (U.S.) in 2018 up 20 per cent from $133.8-million in 2017. How much of the revenue is derived from the U.S. market and how will the reduction in the U.S. corporate tax rate impact them?
In the third quarter, that number was 87 per cent… Out of my coverage universe, this company is best positioned to benefit from the new tax reform legislation… We lowered our tax rate for these guys from 33 per cent to 25 per cent. We also increased the depreciation and amortization rate associated with the tax reform, which is another benefit for these guys. The result was we increased earnings by 9 per cent or 11 cents in 2018 and we increased earnings by 10 per cent or 16 cents in 2019. What it does is add about $5-million (U.S.) per year of incremental cash flow to the company.
Your target price is $88 (Canadian). How do you arrive at that price?
We use a 9 times blended [EV/Sales multiple] on 2018/2019. Historically, that multiple has been as high as 10 times…We are starting to see EBITDA margins expand north of 30 per cent and that is because they are able to leverage their system integrators not only on the sales side but also on implementation and we expect that to continue and long-term we expect this company to start posting EBITDA margins north of 40 per cent…Having said all that, we think that long-term, as this company reaches a more mature state, we think that there is more opportunity for growth and we think that [the stock price] could double in value, certainly over the next five plus years.
What are the catalysts?
The biggest near-term catalyst to me is 2018 guidance, which we get next month… That will give us an indication as to how sales growth, again driven by these system integrators, and how EBITDA margin with the underlying system integrator contributions are tracking. That is the first catalyst and then the second catalyst is, these guys don't necessarily announce wins, the only reason they are far and few is because sometimes they don't always get the green light from their customers to announce it, so any sizable contact announcements could be another catalyst.
Your final stock recommendation is Savaria and you have a target price of $19.75.
They are benefiting from solid industry fundamentals, which is an aging population and how they benefit is by providing lift equipment [home elevators, stair lifts, etc.] to the market. [They have a] solid management team, they have sizable insider ownership and these guys are very EBITDA focused. What they did years ago, more than 10 years ago, is source materials out of China.
What is your investment thesis?
M&A is a large part of the story and they have had a successful track record of doing it and I think it will continue to be a large part of the story going forward. They have done a great job at integration, and integration for the purposes of driving higher margins. As a result of that, when you layer on the fact they are working in an industry that has solid fundamentals because you are benefiting from an aging population, you've got good top line fundamentals combined with operating leverage that the company has been able to deliver on. We think that there is more margin expansion to come, more cash flow generation to come, and these guys have a good track record of delivering on dividend growth. As a result, we think that these guys could even be eligible for the Aristocrats Index and that would open up the investor base to include more and more dividend investors.
The company just announced an acquisition to get them into the Australian market. We think there are other markets that they can enter, including the Asian market. We think there are more opportunities for them to expand margins by acquiring geographic presence within the U.S. All that is to say, the company's target is to get to $500-million in sales in four to five years, we think if they are able to deliver on that, the stock [price] could be in the order of $30.
Do you think the company may be added to the Dividend Aristocrats Index in 2018?
If they are going to be eligible, I think we could see that in early 2019.
Your target price is $19.75. You believe the stock deserves to trade at a premium valuation. Why?
The way I look at this company, there are three buckets of multiples that I look at. The first one is general lift companies, and these guys trade in the 10 to 11 times range [forward EV/EBITDA]. They tend to have lower growth and more importantly lower margin profiles. The second bucket I look at is medical equipment companies, they tend to trade at 13 to 15 times with a little bit better margin profiles and better growth profiles as well. The last bucket is specialized medical equipment; the multiples there are 14 to 16 times, or higher. They have very similar operating metrics as Savaria. To me, it's the second and third buckets that I tend to drive off of as far as the multiple is concerned. The other thing is I use a 16 multiple because I am including two multiple turns [e.g. A 14 times multiple plus a two times multiple] to reflect further M&A activity. As much as it [M&A] was a theme in 2017, we think it continues to be a theme for 2018.
Does the company have the financial capacity to fund this growth?
Cash on hand currently sits at $11-million. They do have just over $40-million of debt; however, they also have lines of credit that gives them access to over $100-million of credit that they could tap into. The balance sheet it not overly levered at the moment. So they could, in our opinion, lever up the balance sheet further to get transactions done without necessarily tapping the equity markets.
Is there a catalyst for Savaria that could drive the share price higher?
If there is a near-term catalyst with the company it's going to be quarterly results and M&A announcements.
With all three of these companies, insider ownership is significant, over 30 per cent for each company. Is that correct?
It definitely is correct for Savaria. In the case of Solium, it is correct when you include management, including the chairman, 30 per cent, give or take, is about right. In the case of Kinaxis, that would be correct, including the chairman.
This Q&A has been edited and condensed.
Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market.
Jennifer Dowty