Constellation Software’s Q2 was soft, says National Bank

Constellation Software (Constellation Software Stock Quote, Chart, News TSX:CSU) is reasonably valued at its current price, says National Bank Financial analyst Richard Tse, who in an update to clients on Monday reviewed the company’s recent Q2.

Toronto-based growth-by-acquisition name Constellation Software released its third quarter financials last Thursday, reporting revenue up 15 per cent to $870 million from a year earlier and net income up 24 per cent to $82 million year-over-year. Constellation completed a number of acquisitions over the quarter ended September 30, 2019, for aggregate cash consideration of $278 million, while subsequent to September 30, management has so far reported completing or entering into agreement to acquire an unspecified number of businesses for cash consideration of $56 million. (All figures in US dollars unless where noted otherwise.)

Q2 was soft for Constellation, analyst says..

Tse, who says Constellation’s second quarter was soft, saw the Q3 as coming in below expectations. The $870-million top line was below his $881.0-million estimate as well as the $879.0-million consensus forecast, while CSU’s adjusted EPS for the quarter of $7.27 per share was also below his estimate of $7.76 per share and the Street’s $7.71 per share.

“The positive datapoint from the quarter was the pace of capital deployment picked up, taking the Company’s YTD capital deployment to $525 million. In our view, Constellation will need to deploy ~$175 million in capital in Q4 if it’s to make our F2020 estimate based on our run-rate analysis. On that note, Constellation has entered into agreements in the amount of ~$79 million which suggests that it’s achievable. That said, the environment for acquisitions continues to be more competitive,” writes Tse.

Constellation’s organic growth for the quarter was down two per cent year-over-year, and Tse made note that the company’s licensing segment was particularly weak at negative 14 per cent year-over-year. The decline in licensing revenue has been an issue in five of the last eight quarters, says Tse, who offers that while there has been no indication so far from management, the culprit could be acquisition accounting and/or the potential impact of SaaS-based models on Constellation from a competitive perspective.

“Bottom line, while there’s no denying there’s growth ahead and that Constellation remains one of the best acquisition growth companies in our coverage universe, it’s also priced that way particularly if we look at free cash flow,” says Tse.

Down slightly since the Q3 release last week, CSU remains up 48.8 per cent for the year, having reached a high of C$1356.82 per share on October 15.

Tse thinks that Constellation Software will round out fiscal 2019 with revenue of $3.470 billion, EBITDA of $957 million and adjusted EPS of $29.02 per share. For fiscal 2020, the analyst is expecting a top line of $3.959 billion, EBITDA of $1.086 billion and adjusted EPS of $36.18 per share.

With the new report, Tse is maintaining his “Sector Perform” rating, “Above Average” risk rating and C$1,400.00 per share target, which represents a projected return of seven per cent at the time of publication.