Is Kinaxis overvalued?

You always want to resist buying a stock because you like the company, and that’s the case for Canadian supply chain management software name Kinaxis (Kinaxis Stock Quote, Chart, News, Analysts, Financials TSX:KXS), according to portfolio manager Brian Madden of Goodreid Investment Counsel. Madden says while Kinaxis has done well in building out its business internationally, the stock is still ahead of itself, even with the pullback over the past two quarters.

“We’d be leery about buying Kinaxis, mainly because of valuation which we think is out of step with fundamentals,” said Madden, speaking on BNN Bloomberg on Wednesday.

“Make no mistake, this is a great business — they provide enterprise software to large companies to help them to manage their supply chains. Their product is called Rapid Response and it’s deployed globally, with most of the revenue coming from outside of Canada in the US and Europe and so on,” Madden said.

“But the problem here is the stock trades at 230x 2021 earnings which is a bit rich for our blood,” he said.

Kinaxis was one of the first tech stocks out of the gate soon after the pandemic-induced pullback in February and early March of last year. KXS doubled in value over the space of a few months, hitting an all-time high of $223 by early August of last year. That was after years of a slow but consistent climb from about $20 back in 2015 to $110 by early 2020.

But the stock started fading by the fourth quarter last year and is currently trading at around $165, which makes KXS about even for 2021 but well off its high.

At the same time, Kinaxis’ business is doing very well, showing a nine-per-cent year-over-year increase in revenue in its latest quarter, the company’s first quarter 2021 delivered in early May.

Total Q1 revenue was $57.7 million, with SaaS business making up the bulk of that at $40.6 million and representing an 18-per-cent year-over-year increase in that segment. Yet earnings were down, with adjusted EBITDA coming in at $9.0 million compared to $15.1 million a year earlier.

Kinaxis’ EBITDA margin took a hit, coming in at 16 per cent compared to 29 per cent for the first quarter 2020, with the company accounting for the drop as part of the normal cycle of subscription term license revenue, coupled with ongoing expansion investments.

“While COVID-related delays are not fully behind us, the environment for booking new business, which started to show signs of improvement in the fourth quarter of 2020, has continued to return to a more normal state,” said CEO John Sicard on the first quarter earnings call. “We won a record number of new customers for a first quarter which, together with project expansions, resulted in record first quarter incremental subscription bookings.”

Management’s guidance is for a nine-per-cent increase in revenue for 2021 over the previous year, with SaaS revenue expected to grow by between 17 and 20 per cent. At the same time, the company put its adjusted EBITDA margin down as likely between 11 and 14 per cent.

Madden says the growing gap between revenue and earnings should be a red flag for would-be investors, along with KXS’s valuation.

“[The stock] had a bit of a stumble earlier this year, and that’s why you saw that 45-per-cent correction from roughly June of last year through to March of this year,” Madden said.

“If you take 2022 to be a more normalized year and a better indicator of their ongoing earnings power it’s still trading at 93x earnings, which might be fine for some aggressive growth investors if in fact it was growing both the top line and the bottom line rapidly,” Madden said. “It’s growing at a respectable pace but the issue here is that sales are growing more rapidly than earnings and their margins are shrinking and the end result of all that is it rolls up to just a 12-per-cent compound growth rate in earnings.”

“We can find companies growing at 12 per cent in the tech sector trading at 16x or 17x earnings, and in fact we own the likes of those rather than this one, which is flashy or sexy or more on trend but we just don’t think that the growth rate justifies the valuation of the stock right now,” Madden said.

Sicard said the COVID pandemic along with events such as the container ship blocking the Suez Canal earlier this year show how important proper supply chain management is to businesses worldwide.

“You start to see how invaluable concurrent planning is for our customers,” Sicard said in the Q1 earnings call. “The weakness of rigid legacy cascaded techniques that introduce latency in planning and follow functionally siloed approach are being exposed every day. I am confident that Kinaxis has never been in better position to serve our markets.”