2 technology stocks to buy

CIBC analyst names two technology stocks in the software industry helping other companies adapt the use of digital technology in all aspects of business as “outperformers”.

technology_stocks

Here are two Canadian companies helping others adapt the use of digital technology in all aspects of business.

Many months after March 2020, most of us have become almost too familiar with, for example, video meetings with colleagues and clients (to say nothing of friends and family), but the “digital transformation” of businesses continues to pick up steam, according to CIBC World Markets equity analyst Stephanie Price.

Living in the Toronto area, Ms. Price is responsible for software and services stock coverage at CIBC, which she joined in 2006 as an associate. Previously she worked as an analyst at RBC and the Bank of Montreal. She is also a chartered financial analyst.

Two of her favourite companies, CGI Inc. (TSX—GIB.A; NYSE—GIB) and Enghouse Systems Ltd. (TSX—ENGH), are helping other companies adapt the use of digital technology in all aspects of business, from communications (internally and with clients) to operations management, safety and security, inventory, and sales. She considers both to be “outperformers” compared to the competition, CIBC’s highest recommendation.

Ottawa-based CGI spans the globe

CGI is an IT services, outsourcing and consulting firm operating internationally. According to its three-year growth plan, the company intends to increase revenue through its proprietary software as well as consulting. “CGI plans to grow IP (intellectual property) revenue to 30 per cent of overall revenue by 2025, up from low-20s percentage levels today,” she explains. The analyst predicts that growth will come from a combination of internal software development as well as new solutions that it acquires. Per management commentary to the analyst, the company intends to spend between $800 million and $1.2 billion “on metro market and tuck-in acquisitions” in 2022.

Speaking to the geographic diversity of the company, Ms. Price notes, “CGI’s M&A (mergers-and-acquisitions) focus is on 16 primary countries and 200 metro markets. The analyst continues, “CGI has started fiscal 2022 strong, with two transactions”. She highlights one of these, Cognicase Management Consulting in Spain, as a good example of the type of “metro market deal” CGI is seeking. “The acquisition brought 1,500 new employees in a geography that CGI was looking to scale in. The acquisition also added key client relationships, including Santander Group, BBVA [Banco Bilbao Vizcaya Argentaria, S.A.], and Telefonica.”

Another avenue of growth for the company is digital projects, where it expects business to expand by more than 10 per cent in coming years. “CGI’s digital work is typically composed of high-end strategic consulting projects and end-to-end digital modernization work that involves cybersecurity,” says the analyst.

Ms. Price also praises the company’s ability to keep talented employees on board. “While CGI has seen an increase in wages, it has been able to pass increased costs along to clients given the value placed on digital transformations. Attrition rates have ticked up as the pandemic recedes, but they remain below the industry average.”

The analyst adds: “Despite an improving business environment, CGI continues to trade below its pre-COVID levels of 21 times forward earnings. We note that (peer) Accenture (PLC) has seen its valuation accelerate well beyond its pre-COVID levels as the company recorded solid revenue growth and continued margin strength.”

Is Enghouse “exploring strategic options”?

Enghouse Systems is an enterprise software provider headquartered in Markham, Ontario, with four business segments divided into “interactive management” and “asset management” groups. Those segments include video conferencing solutions for banking and tele-health; software and services to facilitate business growth through any point of contact (such as a work-from-home call centre); and Internet-based broadcasting technology. (The first two segments form the interactive group.)

Remarking on a November Bloomberg report that Enghouse “is exploring strategic options”, Ms. Price points out that the company’s management declined to elaborate, stating only that it does not comment on any type of M&A processes. Based on management’s coy reaction and current high takeover-target valuations, the analyst deduces that a large acquisition is unlikely, but a sale of part or all of the business could make sense given those elevated prices and management’s focus on returns.

“We see Enghouse as a relatively strong candidate for a private equity take-out given net cash of $184 million, cash conversion over 90 per cent, a five per cent free cash flow yield, and strong ROIC (return on invested capital).” She adds, “If Enghouse were looking to divest a portion of its business, we see the interactive management group as potentially the most likely given recent M&A activity in the space. . . . We believe that the most likely buyer of the division is a UCaaS (unified communications as a service) provider that is looking to offer a combined video and contact centre solution.

According to the analyst, Enghouse traded at about 18 times its EBITDA (earnings before interest, taxes, depreciation and amortization) over the last 12 months, while recent contact centre transactions have been completed at much higher multiples.

This is an edited version of an article that was originally published for subscribers in the December 17, 2021, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

Comments are closed.