There are a bunch of reasons why investors should be owning Canadian software giant Constellation Software (Constellation Software Stock Quote, Charts, News, Analysts, Financials TSX:CSU), including the wide moat of having tonnes of businesses in its stable. But if you don’t already own it, portfolio manager Chris Blumas thinks you may want to wait for a better entry point.
“Constellation is a company that I know very, very well. It’s a wonderful company,” says Blumas of Raymond James Investment Counsel, speaking on BNN Bloomberg on Tuesday.
“It’s a software company and what their focus is is acquiring smaller software companies. In terms of their financial model, they’re a very, very disciplined acquirer,” he said. “They have very high hurdle rate and they’ve done a lot of acquisitions over time.”
“What they do is they buy other smaller software companies that aren’t growing, and then they integrate them within their platform, and they’ve done a tremendous job compounding capital over the very long term. They’re one of the best compounders in Canada, and it’s a name that I know and I really, really like.”
Constellation has been one of the premier Canadian tech stocks to own over the past decade, delivering continuous growth in share price over the years, including this year where the stock is currently up about 26 per cent. That’s compares well with the broader S&P/TSX Composite which is up about 16 per cent.
But those gains this year have made CSU perhaps a bit expensive at the moment, according to Blumas.
“I think the only thing you have to watch with Constellation is valuation,” he said. “In terms of its current valuation, I would just wait for a little bit of a pullback here from time to time.”
“Sometimes given the acquisitions that are in the pipeline and contract renewals on the software side, they tend to have a lumpy quarter, and when they have these lumpy quarters and they miss expectations I think that’s a really, really good time to swoop in and buy it,” Blumas said.
“I think it’s a great long term hold, so even if you went in at current levels the free cash flow yield is just a bit under three per cent right now, so … I would wait for a little bit more of a pullback,” he said.
Earlier this month, Constellation released its second quarter 2021 financials, showing overall revenue growth of 35 per cent year-over-year (14 per cent organic growth or eight per cent after adjusting for foreign exchange) for a topline of $1,249 million. Net income attributable to shareholders grew by seven per cent to $88 million or $4.16 per diluted share. Meanwhile, cash flows from operations dropped by 28 per cent for the quarter.
On the M&A side, CSU completed $292 million worth of deals in the Q2, with the company reporting $122 million in aggregate acquisitions so far since the end of the quarter.
Earlier this year, Constellation completed the spin-off of European software business Topicus (topicus.com Stock Quote, Charts, News, Analysts, Financials TSXV:CSU), giving CSU shareholders about 1.86 Topicus shares for every Constellation share. So far, Topicus, which trades on the TSX Venture Exchange, has been a winner, with its share price climbing a whopping 80 per cent since its debut on January 2.
Blumas says there’s value in owning both stocks.
“Topicus has just released one quarter as a separate public company, and it has a very similar M.O. to Constellation, it’s just in a slightly different market — it’s more focused on Europe,” Blumas said.
“It’s not one that I’ve been adding to, just because of its size and its listing on the Venture, but I haven’t sold it as well,” he said. “With Topicus, I think it makes a lot of sense to watch and wait. I think in the end you’ll do quite well in both of them because they have very similar operating attitudes in terms of capital allocation and I think the incentives and the structures in place for managers are very, very conducive to growth. So I do like both of these companies.”
Blumas says Constellation’s strength lies in the diversity and breadth of its holdings, which make for a stability over time that’s attractive for investors.
“Anything can happen [but] what allows this one maybe a higher degree of certainty is it’s an accumulation or an aggregation of so many smaller companies that no one product dominates the portfolio. So, they could have a problem with a single product and it wouldn’t affect the whole ship,” Blumas said.
“And so I think from a diversification standpoint in the software space, Constellation is absolutely, phenomenally well diversified. It’s more of a private equity firm that focuses on software,” he said.
“Over time, if growth in cash flows and earnings were to moderate a little bit, that could impact valuations. I think valuation is your biggest risk with Constellation,” he said.