NSIT - CDW Vs. Insight: Which Is The Better Buy?

2023-03-30 08:38:25 ET

Summary

• Both CDW Corporation and Insight Enterprises stocks have beaten the S&P 500 in the last 12 months.
• The IT distribution sector enjoys favorable long-term trends.
• A comparison of the financial performance and valuation of CDW and Insight suggests value investors might prefer CDW whereas growth investors might prefer Insight.

At Leads From Gurus, we keep an eye on guru portfolios to identify lesser-known, small-cap stocks that could potentially beat the market in the long run. David Rolfe, the Chief Investment Officer of Wedgewood Partners, remains long CDW Corporation ( CDW ) although he trimmed his stake in Q4 2022, which prompted me to take a closer look at the company although CDW is not a small-cap stock by any stretch of the imagination. CDW is among the top 10 holdings of David Rolfe, representing close to 6% of his portfolio. While evaluating the competitive landscape for CDW, I came across Insight Enterprises, Inc. ( NSIT ), a smaller company that competes with CDW. Both these companies have outperformed the S&P 500 index in the last 12 months, with CDW gaining 4% and NSIT rising 30% against the 12% decline of the S&P 500. Both these companies seem well-positioned to grow but investors, depending on their risk tolerance level and investment objectives, will find one more attractive than the other.

Two Similar Businesses

CDW Corporation is a leading provider of technology solutions for businesses, government, education, and healthcare sectors. The company has a strong presence in the United States, Canada, and the United Kingdom, and its customers include more than 250,000 SMEs as well as government agencies, educational institutions, and healthcare providers.

CDW's product portfolio includes hardware, software, networking, security, cloud computing, and data center solutions. The company partners with leading technology vendors, such as Dell Technologies ( DELL ), Cisco Systems ( CSCO ), Hewlett Packard Enterprise (HPE), Microsoft Corporation ( MSFT ), and VMware ( VMW ) to provide their customers with the latest technology products and services. CDW's expertise in technology solutions and the recognition for its outstanding customer service have been key to securing these partnerships with top technology vendors.

In addition to its product offerings, CDW also provides value-added services, such as configuration, installation, and support, to help its customers optimize their technology investments. CDW's configuration services include custom imaging, asset tagging, and kitting, among others. The company's installation services cover everything from basic hardware installation to complex networking and data center solutions. CDW's support services include managed services, remote technical support, and on-site services.

If you have not heard about the company, the easiest way to understand CDW is to think of the company as a middleman between tech product vendors and their customers. CDW adds value to both these parties, as illustrated below.

Exhibit 1: CDW's value proposition

Insight Enterprises is a direct competitor of CDW, which offers similar products and services to technology vendors and their customers. The company identifies itself as a digital transformation enabler providing a wide array of solutions ranging from hardware, software, and services. Similar to CDW, Insight has prioritized the cloud solutions segment in recent years. As illustrated below, Insight also works as a middleman in the IT solutions industry.

Exhibit 2: Insight's value proposition

Similar to CDW, Insight also serves customers of all sizes including SMEs, government institutions, educational institutions, and healthcare companies.

The Covid-19 pandemic has expanded the target market for both these companies as the rise of remote working has forced many businesses to transform into digital-friendly workplaces.

Financial Performance Comparison

CDW Corporation delivered strong 2022 full-year sales, however, sales declined in the fourth quarter due to macroeconomic challenges. The company reported a decline of 1.8% in total net sales in Q4 to $5.44 billion. The Corporate segment net sales increased by 6.9%, but the Small Business and Public segments experienced revenue declines of 13.1% and 8.7%, respectively. These declines were primarily caused by a decrease in net sales to education customers, which was offset by growth in sales to government and healthcare customers. CDW's UK and Canadian operations also reported a decline in net sales.

Insight also reported a 2% decline in net sales to $2.5 billion. Product sales declined by 4% while the services segment continued to build on its recent strength by registering a 9% YoY revenue growth. Similar to CDW, Insight also reported a notable decline in EMEA revenue.

In Q4, both companies saw an increase in gross margins but CDW came on top as the winner with a 410-basis point increase in gross margins compared to 180 basis points for Insight. Both companies benefited from a shift toward services revenue but CDW's pivot toward services revenue was of a higher magnitude aided by recent acquisitions. CDW has only recently begun to prioritize the services segment although the company has been involved in this business for a while. According to data from the company's latest annual report , services accounted for 7.8% of total revenue in 2022, an improvement from 5.4% and 4.9% in 2020 and 2021, respectively.

Exhibit 3: CDW's sales mix

CDW Corporation has broadened its services portfolio by acquiring other companies, which has played a significant role in its recent success. In February, the company purchased Locus Recruiting LLC, a consulting team that specializes in information security, cloud computing, networking, and infrastructure. The acquisition of Locus is anticipated to help CDW address its clients' intricate IT problems. According to CDW's Chief Commercial and Operating Officer, Chris Chorley, Locus's expertise will allow the IT distributor to expedite its ability to meet the increasingly complex and interconnected demands of its clients. Locus has a track record of providing technology solutions in the network, cloud, and security sectors to some of the world's most prominent companies. With this acquisition, CDW aims to expand access to high-quality talent to bolster its services business by showcasing that it possesses the know-how to meet complex customer demands in cloud, security, and networking segments.

According to Insight's 2022 annual report , services accounted for just over 14.2% of revenue last year, which shows how the company relies more on services compared to CDW. Insight, back in 2015, unveiled a new strategy with a focus on IT services, and the higher contribution from the services segment is a direct result of this decision.

The majority of the revenue decline reported by CDW and Insight in Q4 can be attributed to economic uncertainty, which led customers to de-prioritize endpoint solutions and delay client device upgrades. To address these challenges, both companies pivoted to help customers maximize prior IT investments, identify savings opportunities, and prioritize mission-critical areas such as security and the cloud. The government segment remains a bright spot for the IT solutions industry, driven by the adoption of hybrid cloud, network modernization, and the rising demand for Zero Trust security frameworks.

Despite the challenging market conditions, CDW and Insight remain resilient as these companies continue to address customer priorities with their broad portfolio around security and cloud, and the focus on the healthcare and government sectors will help offset some of the declines in sales.

Valuation Comparison

CDW and Insight are two comparable companies but the former is a much larger entity. The company has grown in size at a faster pace than Insight (CDW was incorporated in 1984 while Insight was founded in 1988) aided by strategic acquisitions and aggressive international expansions.

Source: Seeking Alpha

A quick look at the revenue and market capitalization of these companies reveals that they are cheaply valued from a price-to-sales perspective. Before we get to compare the valuation multiples of the two companies, it is important to establish whether these companies are growing at a similar pace.

Over the last 5 years, CDW's revenue has grown at a compounded annual growth rate of 9.87% whereas Insight's revenue has grown at a CAGR of 9.25%. There is nothing much between the two companies to suggest one company deserves a premium valuation based on revenue growth trends alone. Insight's profitability, however, has improved at a better pace compared to CDW in the last 3 years.

Source: Seeking Alpha

Based on the profitability trends, Insight deserves to trade at higher multiples. It is worth mentioning, however, that CDW's margins are superior, and the company has consistently delivered higher ROIC compared to Insight.

From a relative valuation perspective, Insight is considerably cheaper than CDW today although the financial performance of these two companies does not warrant a meaningful difference.

Source: Seeking Alpha

Despite Insight being cheaply valued compared to CDW, NSIT has delivered a substantially better market performance over the last 5 years.

Exhibit 4: CDW vs NSIT

One possible reason behind CDW's premium valuation is its strong track record of dividend distributions. As the smaller company of the two, Insight is well-positioned to grow faster than CDW in the next few years, which suggests Insight is attractively valued compared to CDW today.

Takeaway

A value investor looking for cheap, profitable, market-beating tech stocks might find CDW an attractive bet whereas growth investors looking for a small-cap opportunity in the tech space might find NSIT a better bet. Both CDW and Insight are well-positioned to grow in the coming years aided by favorable long-term macroeconomic trends and a positive shift in the revenue mix.

For further details see: