Converge Technology is heading higher, says Eight Capital

Hybrid IT solutions company Converge Technology Solutions (Converge Technology Solutions Stock Quote, Chart, News, Analysts, Financials TSX:CTS) saw its share price take off over a 12-month stretch during the pandemic but the stock has drifted in recent months. Now, Eight Capital analyst Christian Sgro thinks it’s time to capitalize on Converge, with the analyst maintaining a “Buy” rating while raising his target price from $14/share to $14.50/share for a projected return of 45 per cent in an update to clients on Friday.

Toronto-based Converge Technology Solutions operates in both Canada and the United States, providing storage devices and systems, computer products, software, along peripherals and accompanying support to corporate and government institutions.

Sgro’s strengthened sentiments on Converge come as the company released preliminary fourth quarter financial results, which he noted to be ahead of consensus estimates across the board.

“Despite supply chain headwinds this past year, the company reported 9.6 per cent organic growth for the full year which we believe to be at the high end of industry-average five to ten per cent,” Sgro said. “With an increased sequential bookings backlog of $350 million at year-end and the potential for these constraints to begin unwinding across select vendors, we expect that 2022 can be stronger than previously anticipated and have raised our estimates.”

On a preliminary basis, Converge’s financial results are headlined by a midpoint revenue of $501 million, representing 36 per cent sequential growth and a 73 per cent year-over-year increase. The reported figure also comes in ahead of the Eight Capital expectation of $471.9 million, as well as the consensus estimate of $475.8 million.

Converge also performed well in its preliminary margin reports, with its guidance of $115 million in gross profit for the quarter producing a margin of 23 per cent, in line with the Eight Capital expectation of $111.4 million and a 23.6 per cent margin, as well as with the consensus projection of $110.3 million and a 23.2 per cent margin.

The company’s preliminary adjusted EBITDA report also produced a positive, indicating guidance of $33.5 million and a 6.6 per cent adjusted EBITDA margin to come in ahead of the Eight Capital estimate of $29.8 million and a 6.3 per cent margin, along with the consensus projection of $29.3 million and a 6.2 per cent margin. 

”We are extremely proud of our organization’s outstanding performance in 2021 and look forward to deepening our customer relationships and continued expansion into 2022,” said Shaun Maine, CEO of Converge Technology Solutions in the company’s February 17 press release. “The fact that we experienced such strong growth despite supply chain issues that have been experienced industry-wide throughout 2021 bodes extremely well for 2022, especially since we have a backlog in excess of $350 million.” 

The preliminary results have prompted Sgro to revise a number of future financial forecasts for Converge, raising his year-end revenue target for 2021 from $1.49 billion to $1.524 billion to break into 10 figures at a 60.6 per cent year-over-year increase. From there, Sgro raised his 2022 revenue target from $2.323 billion to $2.369 billion for a projected year-over-year increase of 55.5 per cent.

Accordingly, Sgro projects the company’s EV/Revenue multiple to drop from 2.1x in 2020 to 1.3x in 2021, then dropping again to a projected 0.8x in 2022.

From a margin perspective, Sgro raised his adjusted EBITDA projections, as he now projects the company to end its 2021 fiscal year at $92.4 million and a 6.1 per cent margin (previously $89.1 million and a six per cent margin). Sgro also raised his 2022 adjusted EBITDA projection from $175.4 million to $179.6 million, with the margin projection remaining at 7.6 per cent.

In terms of valuation, Sgro introduces an EV/adjusted EBITDA projection of 21.3x in 2021, followed by a drop to a projected 11x in 2022.

Sgro mildly raised his gross profit projection for 2021 from $341.3 million to $344.8 million, though the projected margin also drops from 22.8 per cent to 22.6 per cent. Looking ahead to 2022, Sgro raised his forecast from $565.8 million to $575 million, though the margin decreases minimally from 24.4 per cent to 24.3 per cent.

Overall, according to Sgro’s figures, Converge presents a discount trading at 11x 2022 EV/adjusted EBITDA compared to the peer group at 13.2x.

The analyst said Converge has access to about $475 million in pro forma funds to support M&A activity.

“We believe Converge deserves to trade at a premium to peers due to execution to date and because of the significant dry powder which we think is sufficient to add $1 billion of accretive and strategic revenue to the current profile,” Sgro said.

Converge’s stock price has catapulted upward by 66.8 per cent over the last 12 months, though investors who came on board at the start of 2022 have experienced a 6.4 per cent loss in that time. Converge’s 52-week peak came on September 7 at $12.85/share, a long way from its low of $5.16/share on March 30 in the same time period.