OpenText is a solid buy, this investor says

Are tech stocks looking too expensive? One name that seems to have underperformed is OpenText (OpenText Stock Quote, Chart, News, Analysts, Financials TSX:OTEX), which should be good not only for a long-term hold, says portfolio manager Brian Madden, but could very well get a lift with its earnings report on Thursday.

Waterloo, Ontario-headquartered OpenText is an enterprise information management company with a long history of doing well by its investors, as witnessed by its 360-per-cent return over the past ten years. That’s on top of that rare gem of the tech field, a dividend that’s been running since 2013 and currently yields about 1.7 per cent.

But OTEX had a rougher year in 2020 than most, as it had trouble recouping ground lost in the general market pullback in February and March and finished the year up just one per cent. That’s in contrast to the wider tech sector which had a monster year. The S&P/TSX Capped Information Technology Index, for example, posted gains of 52 per cent in 2020.

But Madden, senior vice president at Goodreid Investment Counsel, thinks investors can’t go wrong with OTEX which he characterizes as a very well-run company.

“This is another one of our poster children for the growth by acquisition strategy,” said Madden, speaking on BNN Bloomberg on Wednesday. “OpenText is a cloud and site based enterprise content management and sharing information management software and solutions provider, with a quite large installed base of over 100 million users at 10,000 companies globally.”

“Almost 90 per cent of their revenues are recurring so that gives them good sales visibility. About 95 per cent of the revenue originates outside of Canada in the States and in Europe, and, as I mentioned, they’re a great consolidator of a fragmented industry: they’ve deployed $6.8 billion since 2010 on a string of acquisitions which have been very accretive to their earnings, and they have a strong balance sheet and should be ready to fire up that acquisition machine again,” he said.

Despite what the share price might be saying, OpenText actually performed well in 2020. Revenues climbed by 10.6 per cent year-over-year to $826.6 million for its fiscal fourth quarter, delivered in early August, and then increased by 15.4 per cent to $804.0 million for its fiscal first quarter 2021, delivered on November 5. (All figures in US dollars except where noted otherwise.)

For the Q1 2021, OpenText saw free cash flows jump a full 84.0 per cent to $218.6 million, while adjusted EBITDA was up 34.7 per cent year-over-year to $342.3 million, with a margin of 42.6 per cent.

Those were record performances across all key metrics, said OTEX CEO Mark J. Barrenechea.

“We demonstrated outstanding execution in a challenged environment with total revenues of $804.0 million, an increase of 15.4 per cent year-over-year and Cloud Services and Subscription revenues of $341.0 million, an increase of 43.7 per cent year-over-year, being our largest revenue contributor,” Barrenechea said in the quarterly press release.

“Our Annual Recurring Revenues grew 22.0 per cent year-over-year to $670.4 million and now represents 83 per cent of total revenues. These record results demonstrate the strength and resiliency of our business, supported by a predictable Annual Recurring Revenue framework, that we believe positions OpenText very well for future cloud growth and market share gains,” he said.

Those Q1 numbers were beats of analysts’ estimates, as well, with the $804-million in revenue besting the consensus forecast by almost $50 million while the $342.3-million EBITDA also beat the Street’s call for $277 million.

Reviewing the first quarter results, National Bank Financial analyst Richard Tse said in an update to clients on November 6 that they were some of the best he’d yet seen from OTEX, according to a report in the Globe and Mail.

Tse said the stock’s performance up until then showed a valuation disconnect and that OpenText was one of a number of legacy names currently being ignored by investors.

As of a January 12, 2021, research note, Tse has OpenText with an “Outperform” rating and $55 target, which at the time of publication represented a projected 12-month return of 28 per cent.

The share price has responded well since then, however, gaining about 17 per cent over the past three months.

Madden says there could be a nice increase with the release of OTEX’s fiscal second quarter, due after market close on Thursday.

“We’re categorically not short-term investors but it should be noted this company is reporting earnings after the close tomorrow and the Street is looking for about eight-per-cent growth in earnings and in sales, and when they do report typically the stock has traded well,” Madden said.

“I think their earnings can hopefully be a bit of a pop there, but we’re a long-term believer in the strategy, the story and the management team,” he said.