Constellation Software is my Top Pick for 2022, this portfolio manager says

The stock may have fallen off a bit but that’s all the more reason to tuck into Constellation Software (Constellation Software Stock Quote, Charts, News, Analysts, Financials TSX:CSU), says Jason Del Vicario, portfolio manager at Hillside Wealth Management. Del Vicario has chosen Constellation as one of his Top Picks for the next 12 months, saying that as far as best-in-class M&A companies go Constellation is peerless.

“[Constellation Software] has certainly been a top pick in the past for me and it will continue to be so and I hope there’s a lesson in me continuously talking about Constellation Software,” said Del Vicario, speaking on a BNN Bloomberg segment on Friday where he delivered three of his top picks in equities.

Del Vicario said his investment management company puts Constellation in its own bracket due to the strength of its business.

“They are our largest position. They are only high conviction position, meaning that they represent ten per cent of our equity weight. We aren’t afraid to have high concentrated positions in high quality, predictable companies at Hillside because, of course, that moves the needle,” he said. “If we were to have a one per cent or half-per cent weight even if it was a tremendously exceptional company it’s just not going to move the needle.”

It hasn’t been a great start to the new year for Constellation, with the stock now off about 12 per cent, but that’s seemingly par for the course for the market’s current climate. Growth stocks are in retreat as central lending rates are rising and investors look for more secure places to park their money. 

CSU looks to be in the middle of the pack in January when it comes to Canadian tech stocks. Shopify is now down a huge 40 per cent for the month and Descartes Systems is down 19 per cent, while CGI Group is down eight per cent and OpenText is down about four per cent. Constellation finished 2021 up 40 per cent for the year.

“Constellation Software is run by arguably the best capital allocators on the planet,” Del Vicario said. “I’ve been saying this now for a number of years, but they are not just exceptional in the in Canada. They are exceptional when put up against their global peers.”

“They’re run by Mark Leonard who does no media interviews and keeps a very low profile, and that is the sign of a CEO that is just laser-focused on increasing shareholder value. He is the owner of the company, a founder of the company, which of course is something that we like here at Hillside,” he said.

Constellation has made a name for itself in acquiring vertical market software companies, those that fulfill a distinct and often niche purpose with their platforms and services and thus can be counted upon for regular software license fees, professional service fees and even hardware sales. 

Constellation acquires a number of such businesses each year — in 2020, for example, CSU spent $477 million on acquisitions, with its focus on small and mid-sized software companies. For its most recently reported quarter, the company’s Q3 2021, Constellation spent $126 million on M&A.

And while much of the company’s growth comes from acquisitions, organic growth figures into the mix as well. CSU’s third quarter, for example, posted revenue up 30 per cent year-over-year to $1.299 billion, with seven per cent of that being registered as organic growth. The quarter also saw net income drop 13 per cent to $107 million while cash flows from operations were up by 25 per cent to $292 million.

“If we look at their financials, they are unbelievably strong,” said Del Vicario. “They are able to generate a return on invested capital greater than 30 per cent even as they scale up, which is tremendous and is also very, very difficult to do.”

Constellation, which has a small dividend yielding currently 0.25 per cent, gave shareholders a gift early last year of shares in newly spun out company Topicus (Topicus Stock Quote, Charts, News, Analysts, Financials TSXV:TOI). A company with much the same M.O. as Constellation, Topicus is a Dutch firm working on acquiring software businesses in Europe. The company posted revenue up 46 per cent in its third quarter 2021 to €177 million and EPS of $0.09 per share. TOI shares were up about 120 per cent as of early November but the stock has pulled back significantly, leaving the shares now up about 32 per cent since their debut last February.

Del Vicaro says he likes both CSU and TOI over the long term.

“If the viewers don’t own [Constellation], they might like to initiate a position at these levels as they come off from their near highs,” he said. “Constellation Software and Topicus we really feel can offer investors tremendous growth over the next few decades.”