The coronavirus outbreak is going to take a bite out Canadian tech companies and their performance over the next while, according to National Bank Financial analyst Richard Tse who in a coverage update on Monday said that even with the market drop over the past couple of weeks, investors should expect more downside to come.
Stocks slid lower on Monday as the spread of the COVID-19 virus worldwide continues to raise fears about a major economic slowdown. Industries like the airlines and tourism are being hit hard but the damage is across the board, including technology, where Tse said investors should expects valuations to tumble by ten, 15 and as much as 20 per cent as business dries up for Canadian tech names.
Tse says that those number may look severe but they’re certainly within the bounds of possible.
“With major conferences being canceled, limitation of travel, etc. we don’t think its outside the realm of reasonableness to have such potential declines in revenue. No doubt from a profitability perspective we have to apply different assumptions as each name has different attributes with some companies having a more variable cost structure than others,” said the National Bank Financial analyst.
Tse compared the implied valuations from these three ‘What if’ scenarios to the average valuation ranges over the past three years for the tech companies within his coverage to see if those revised numbers were within the valuation ranges or not.
Unfortunately, the analyst said results aren’t good, as the majority of names would have valuations under the ‘What if’ scenario that are above their historical three-year valuation ranges, meaning that as revenues decline, so will those names.
At the same time, while high-flying Canadian tech names like Shopify (Shopify Stock Quote, Chart, News TSX:SHOP) and Lightspeed POS (Lightspeed POS Stock Quote, Chart, News TSX:LSPD) will suffer major pullbacks, Tse is staying bullish on such companies, saying that in the long term when the market settles these investments will be solid.
Until then, however, Tse recommends a number of more defensive names within tech as potential (and relative) safe havens, including OpenText (OpenText Stock Quote, Chart, News TSX:OTEX), and Kinaxis (Kinaxis Stock Quote, Chart, News TSX:KXS).
On OTEX, Tse says that the company’s strong balance sheet and cash flow ($811 million over the next twelve months in free cash flow) from meaningful recurring revenue makes the stock fairly defensive.
Supply chain and logistics software company Kinaxis also has defensive characteristics, according to Tse, as COVID-19 hitting the supply side essentially “underscores the importance of concurrent planning the supply chain, which is Kinaxis’ platform,” said Tse.
Other names that could bring about relative safety include Constellation Software (Constellation Software Stock Quote, Chart, News TSX:CSU), Absolute Software (Absolute Software Stock Quote, Chart, News TSX:ABT) and, potentially, real estate appraisal, lender and mortgage insurer software company Real Matters (Real Matters Stock Quote, Chart, News TSX:REAL) which Tse thinks could escape the worst of the economic downturn based on its business.
On REAL, Tse wrote, “While it’s not on the list above given the relative lower recurring (contracted) revenue, Real Matters is an interesting name given the increasingly lower interest rate backdrop. With both the Fed and BOC cutting rates by 50bps recently, and possibly more cuts on the way, we expect a spike in mortgage re-financings, providing a potential incremental tailwind for a company that had already been gaining market share. The caveat is that while refinancings may spike, it’s too early to tell if new originations would keep pace if this outbreak gets worse.”