DSGX - Descartes Systems: Not Shopping For This E-Commerce Player

Summary

• Descartes Systems has seen quite resilient growth in 2022, despite the choppier market and operating conditions.
• Shares have done quite alright, trading at around 40 times realistic earnings.
• The roll-up strategy continues to be interesting to watch, albeit a bit too expensive here.

In the summer of last year, I concluded that Descartes Systems ( DSGX ) was growing along, as the e-commerce facilitator was employing a sound strategy of organic growth and dealmaking efforts. Despite these ambitions and solid execution, overall valuations remain a bit too demanding in my book.

The company has been seeing some headwinds in the near-term (growth) outlook amidst a reversal in e-commerce growth, tougher comparables, slower economic growth, and the pandemic being on its retreat. That said, the long-term potential remained intact, yet was priced in a bit too much amidst higher interest rates hurting all valuations.

A Recap

Descartes is a Canadian provider of SaaS (logistics) solutions, operating a "total" growth model which is comprised of organic growth and bolt-on dealmaking. Between 2014 and 2020, the company announced 24 deals at a combined cost of $800 million, with typical acquisitions coming in at tens of millions, as the roll-up strategy allows for incremental capabilities and services, to be exported to the rest of the business.

Network solutions include carriers, shippers, intermediates and others, requiring intensive communications to let actual products flow, among others related to reporting, compliance and taxes. Traditional logistics names and large product sellers use these services, as well as many smaller enterprises are among the customer groups which are users.

The company posted an 18% increase in 2019 sales to $326 million, indicating that growth was already seen pre-pandemic. GAAP operating profits rose even in a more pronounced manner, coming at $52 million, with net earnings of $37 million reported at $0.45 per share. A $55 stock early in 2020 translated into a 15 times sales multiple and 100 times earnings multiple, very high valuations.

With shares trading at $60 in 2020, shares rose to $90 in 2021 but fell back to $60 over the past summer as the company has seen continued growth in the meantime. 2020 sales rose 7% to $349 million as GAAP operating profits rose to $71 million, that is even after a $56 million amortization charge. Adjusted earnings came in at $1.10 per share, quite a realistic number, with net cash balances have grown to $133 million.

2021 sales growth accelerated with sales up 22% to $425 million as earnings rose to $1.60 per share, while net cash rose further to $213 million. Trading at $60, the unleveraged business traded at 35 times realistic earnings and 11 times sales. The company posted a solid 17% increase in first-quarter sales in June of last year, setting the company up for the decent fiscal year 2023. Trading at $59, the company was posting earnings at the rate of $1.60 per share, as the company announced some smaller bolt-on deals.

Working with a 10% sales growth assumption, revenues were seen at around $475 million in all likelihood, with realistic earnings seen at $1.60 per share, translating into a still stretched valuation at 35 times earnings. With these valuations multiples coming down, I noted that valuations became a lot more compelling, yet still too demanding given the anticipated sales growth slowdown and risks to the economic outlook.

Doing Well

Since the summer, when shares traded near the $60 mark, shares of Descartes have done quite alright, in fact they have on a net basis risen to $72 per share, having risen some 25% in the time frame of just over half a year.

In September, the company posted an 18% increase in second quarter sales, a resilient performance amidst currency headwinds and slower growth in end markets. Third quarter sales growth slowed down to 12%, as reported in December, as revenues of $121.5 million were even down slightly on a sequential basis.

At this rate, the company is on track to post $480 million in revenues, or a bit more. The company posted GAAP earnings of $0.84 per share so far this year, trending at around $1.15 per share this year. Adding back about $60 million in amortization charge (pre-tax), that suggests realistic earnings numbers of around $1.70 per share. Moreover, net cash has grown to $237 million again, equal to nearly $3 per share based on 86 million shares outstanding.

The business performance has been quite resilient, yet the share price performance has outpaced the operational performance, pushing up earnings multiples to 40 times again.

Another Bolt-On Deal

Despite the slower growth in the business, Descartes started 2023 with a traditional bolt-on deal. The company has reached a deal to acquire Supply Vision, a shipment management solutions provider for Logistics Service providers in North America.

The deal is again quite small, involving a $12 million upfront deal tag, with earn-outs having the potential to increase the total value of the transaction to $15 million. Few details have been announced, with the revenue contribution likely seen in the low single millions, not a game-changer by all means. This is again an indication that Descartes continues to pursue M&A to further grow the business, having ample cash to make such deals.

The reality is that this deal is not a game changer as valuation multiples have risen from 35 times last summer to 40 times in a higher interest rate environment. Amidst challenges in the end markets, such multiple expansion looks quite ambitious. Given all this, I still cannot find myself committing to Descartes here, but it remains a very interesting roll-up player in the space.

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