A blue-chip, multi-sector stock to buy

Open Text has improved the quality of its revenues by increasing the amount of recurring revenues it earns. Higher-quality revenues should help it to continue to deliver the cash flows it needs to grow its business and pay higher dividends.

A_blue-chip_multi-sector_stock_to_buyOpen Text (TSX—OTEX), a blue-chip multi-sector stock, has transitioned itself to a recurring revenue business. In fiscal 2018, which ended on June 30, the company’s annual recurring revenues, or ARR, crossed the $2-billion mark (all figures in US dollars unless otherwise noted). Management regards ARR as a key financial metric because higher recurring business improves the quality of its revenue profile.

In fiscal 2012, ARR made up 54.4 per cent of revenue. This latest fiscal year, that figure has increased to 73.2 per cent. And management is focused on increasing that figure even more.

Open Text is a market leader in enterprise information management software and solutions, enabling companies to manage, leverage, secure and gain insight into their enterprise information, on premises or in the cloud. The company’s vision is to help organizations use new technologies to unlock the power of information, become more intelligent and connected, and drive engagement with customers, partners, and employees.

The company increased its adjusted earnings by 32.0 per cent and its adjusted earnings per share by 26.7 per cent in the latest fiscal year. For the year ended June 30, 2018, Open Text made $683.6 million, or $2.56 a share, compared with $517.7 million, or $2.02 a share, in the same period of 2017.

Customer support contributes to growth

Revenues rose 22.9 per cent to $2.8 billion. Customer support revenues, which increased 25.6 per cent to $1.2 billion, contributed a large part to the overall growth. This growth, in turn, came mostly from Europe, the Middle East and Africa, as well as the Asia Pacific regions. Revenues in both these regions increased by more than 30 per cent.

Open Text’s adjusted EBITDA, meanwhile, rose 28.6 per cent to $1.0 billion. One reason for this is the company was able to limit the increase of its operating expenses to 15.5 per cent.

Open Text focuses on growth through acquisitions and organic activities. The company’s strong cash flows provide the fuel for acquisitions. Cash flow in fiscal 2018 was $824.8 million, up 45 per cent from $568.3 million in fiscal 2017. Free cash flow in the latest period was $573.8 million.

Free cash flow has given Open Text the flexibility to not only make acquisitions, but to reinvest in its business and grow organically. This the company seeks to do through innovation. It believes it can create sustained value through new innovation by expanding distribution and continually adding value to its existing customers. With this in mind, it has targeted about 11 to 13 per cent of its annual revenues on research and development this year.

We believe the long-term outlook for Open Text is positive. Its stock trades at just 13.1 times the company’s likely fiscal 2019 earnings of $2.72 a share. And its annual dividend of $0.61 a share, which was increased 15 per cent in fiscal 2018, yields 1.7 per cent.

Open Text is a blue chip stock to buy for growth and some income.

This is an edited version of an article that was originally published for subscribers in the October 19, 2018, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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