Constellation Software is one of my top picks: Scotia’s Greg Newman

Canadian tech stalwart Constellation Software (Constellation Software Stock Quote, Chart, News TSX:CSU) has done an admirable job in climbing its way out of the hole it and the rest of the market were thrown into just a few short weeks ago.

But with the nifty rally, is there still upside to be had? Sure, says Scotia Wealth portfolio manager Greg Newman, who just gave the nod to Constellation as one of his Top Picks for the next 12 months.

“I think you want to look for software companies and software as a service with solid free cash flow, annuity revenue streams, great balance sheets —this one fits all that,” said Newman, senior wealth advisor and director of wealth management at Scotia, who spoke to BNN Bloomberg on Wednesday. They have a net debt to EBITDA of 0.43 so basically very, very little debt and 69 per cent of their revenue is recurring.”

Constellation Software is one of Canada’s premier growth-by-acquisition stories. Focused on the vertical market software space, CSU has honed its craft over years at picking up smaller companies and accretive acquisitions and spending the new revenue sources on acquiring even more. And with a large portion of its customer base in the public sector, its recurring revenue is solid, even during troubling times like we’re in today.

“They have a history of being able to do very good acquisitions, with very good opportunities,” Newman said. “They’ve got a lot of ammunition to do that in this distressed environment.”

CSU was chugging along just fine until its latest quarterly report in mid-February, which showed revenue for its fourth quarter 2019 up 15 per cent but with negative three per cent organic growth and a net income drop of 49 per cent. For the year, Constellation finished up with 15 per cent revenue growth, negative one per cent organic growth and a net income drop of 12 per cent.

Those numbers apparently displeased the market, as the stock fell almost four per cent over ensuing trading days. Then the bottom fell out of the market starting around February 21 and we all know what happened from there.

But Constellation, which at its lowest was down 29 per cent during the market pullback, has already made up much of that lost ground, now down nine per cent from its early February high.

And Newman thinks there’s more where that came from.

“It's trading at a reasonable multiple and we're estimating that they grow their earnings,” he said. “It’s trading around 20x 2021 [earnings] and we estimate they can grow their earnings around 24 per cent over our time horizon which is 2019 to 2021.”

“So, I think this is another place that you can hang out in. It came down a little bit and I think that it goes higher from here,” he added.

Constellation ended its 2019 with free cash flow available to shareholders of $590 million, up $32 million from a year earlier and having made acquisitions for an aggregate cash consideration of $549 million for the year.