DSGX - Descartes Systems May Accelerate Growth Amid Favorable Acquisition Environment

2023-09-28 14:13:31 ET

Summary

• The Descartes Systems Group Inc. has recently reported strong financial results, beating revenue and matching earnings estimates.
• The company provides logistics and supply chain management software and services worldwide.
• With accelerating revenue growth, growing profits, and a favorable acquisition environment, I'm upgrading Descartes Systems to a Buy.

A Quick Take On Descartes Systems

The Descartes Systems Group Inc. ( DSGX ) reported its FQ2 2024 financial results on September 6, 2023, beating revenue and matching consensus earnings estimates.

The firm provides logistics and supply chain management software and services to companies worldwide.

I previously wrote about DSGX with a Hold outlook.

With top line revenue growth accelerating, profits growing, a strong balance sheet and a more favorable acquisition environment, I’m cautiously optimistic about DSGX in the period ahead.

I’m upgrading DSGX to a Buy at around $73.00 per share.

Descartes Systems Overview And Market

Canada-based Descartes was founded in 1981 to sell a growing range of logistics and supply chain management software solutions to companies worldwide.

The firm is headed by Chief Executive Officer Edward Ryan, who has been with the company since 2000 and was previously Director of Marketing and Field Operations and Vice President of Sales for E-Transport.

The company’s main offerings include:

• B2B connectivity

• Broker and forwarder management

• Warehouse management

• Compliance

• Ecommerce shipping and fulfillment

• Trade intelligence

• Routing and telematics

• Transportation management.

The firm seeks new customers through its in-house direct sales and marketing efforts and through partner referrals.

According to a 2023 market research report by Allied Market Research, the market for supply chain management software and services was an estimated $27.2 billion in 2022 and is forecast to reach $75.6 billion by 2032.

This represents a forecast CAGR of 10.9% from 2023 to 2032.

The main drivers for this expected growth are demand for increased supply chain visibility and capabilities, especially after the disruptions caused by the COVID-19 pandemic.

Also, businesses of all sizes need "seamless product manufacturing, distribution and delivery" functions.

Market growth dynamics through 2023 are shown in the chart below:

Major competitive or other industry participants include:

• Epicor Software

• HighJump

• Info

• IBM

• JDA Software Group

• Kinaxis

• e2open

• Oracle

• SAP

• Manhattan Associates

• Others.

Descartes Systems’ Recent Financial Trends

Total revenue by quarter has continued to grow, as has operating income, per the chart below:

Gross profit margin by quarter has varied within a narrow range; Selling and G&A expenses as a percentage of total revenue by quarter have remained virtually flat:

Earnings per share (Diluted) have increased materially in recent quarters:

(All data in the above charts is GAAP.)

In the past 12 months, DSGX’s stock price has risen only 11.74% vs. that of Manhattan Associates' ( MANH ) significant rise of 46.65%:

For balance sheet results, the firm ended the quarter with $227.4 million in cash and equivalents and no debt.

Over the trailing twelve months, free cash flow was $196.4 million, during which capital expenditures were $6.0 million. The company paid $14.5 million in stock-based compensation in the last four quarters, the highest trailing twelve-month figure for the past eleven quarters.

Valuation And Other Metrics For Descartes Systems

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

As a reference, a relevant partial public comparable would be Manhattan Associates:

(Source - Seeking Alpha.)

DSGX’s most recent unadjusted Rule of 40 calculation was 54.8% as of FQ2 2024’s results, so the firm’s results have slipped a bit, although they are still excellent, per the table below:

(Source - Seeking Alpha.)

Sentiment Analysis

I’ve prepared a chart showing the frequency of various keywords in the company's most recent earnings conference with analysts:

The firm and its clients face ongoing macroeconomic challenges and continuing uncertainties in the current business environment.

Analysts asked leadership about potential headwinds, the M&A environment and peak season shipping outlook.

Management said that it has a diversified business model that isn’t solely tied to shipping volumes and that they are seeing a slightly muted peak shipping volume environment shaping up.

The M&A environment has improved materially, with valuation expectations coming down; management hopes to continue to deploy capital, preferring cash-only deals or with earn-outs if necessary.

Commentary On Descartes Systems

In its last earnings call (Source - Seeking Alpha ), covering FQ2 2024’s results, management’s prepared remarks highlighted accomplishing "record" results for various major metrics.

Management believes the firm is well positioned to ‘thrive in market conditions like these, because we've got good organic growth plus the experience and capital capacity to execute on acquisitions.’

The company is also seeing stronger demand for its visibility solutions, as its broader network across more transportation nodes gives it an edge over competitors, as management sees it.

Management did not disclose any client or revenue retention rate metrics.

Total revenue for FQ2 2024 rose by 16.6% year-over-year, while gross profit fell by 0.9%.

Selling and G&A expenses as a percentage of revenue grew by 0.3% YoY and operating income increased by an impressive 19.8%.

The company's financial position is very strong, with ample liquidity, no debt and impressive free cash flow.

DSGX’s Rule of 40 performance has been excellent, although its results have dropped YoY.

Looking ahead, fiscal 2024’s topline revenue growth rate is expected to be 17.3% over fiscal 2023’s results.

If achieved, this would represent an increase in revenue growth rate versus fiscal 2023’s growth rate of 14.4% over fiscal 2022.

A discounted cash flow calculation indicates the stock may be fully valued at its present price level:

Management sounds confident about the firm’s ability to execute in the current macro environment, and it may be able to acquire capabilities at a cheaper price than before.

However, according to a WTO report , it forecasts a drop in global trading volume in 2023 to only a 1.7% gain over 2022, as the chart shows below:

Against such a "subpar" growth forecast in 2023, the company still appears to expect to accelerate its growth trajectory while producing increasing profits.

Despite an apparently fully valued stock assuming its current free cash flow levels, I’m cautiously optimistic the firm will continue to grow at an enticing rate of growth while taking advantage of lower M&A pricing opportunities in the period ahead.

My outlook on DSGX is a Buy at around $73.00 per share.

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