DSGX - Descartes Systems Thrives As Recession Clouds Gather

Summary

• Descartes Systems Group reported FQ2 2023 financial results on Sept. 7, 2022.
• The firm provides a range of supply chain and logistics management solutions to organizations worldwide.
• DSGX has performed well in recent periods but faces a global slowdown and foreign exchange headwinds.
• I'm on Hold for DSGX for the near term.

A Quick Take On Descartes Systems

The Descartes Systems Group ( DSGX ) reported its FQ2 2023 financial results on Sept, 7, 2022, beating expected revenue and matching EPS estimates.

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

Given continued foreign exchange headwinds and the increasing likelihood of an imminent recession (if we aren’t in one already), as well as management declining to provide full year forward guidance, I’m more cautious on the outlook for DSGX.

Accordingly, while the company may indeed thrive during times of supply chain turmoil, my outlook on DSGX for the near term is a Hold.

Descartes Systems Overview

Waterloo, Canada,-based Descartes was founded in 1981 to provide companies with a growing variety of logistics and supply chain management software solutions.

The firm is headed by Chief Executive Officer Edward Ryan, who joined the firm in 2000 and was previously director of Marketing and Field operations and Vice President of Sales for E-Transport.

The company’s primary offerings include:

• B2B connectivity

• Broker and forwarder management

• Warehouse management

• Compliance

• E-commerce shipping and fulfillment

• Trade intelligence

• Routing and telematics

• Transportation management

The firm acquires customers through its in-house direct sales and marketing efforts as well as through partner referrals.

DSGX also makes selective acquisitions, with the most recent being that of XPS, a multi-carrier shipping platform.

Descartes System’s Market and Competition

According to a 2021 market research report by Allied Market Research, the market for supply chain management software and services was an estimated $18.7 billion in 2020 and is forecast to reach $52.6 billion by 2030.

This represents a forecast CAGR of 10.7% from 2021 to 2030.

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

Also, the chart below shows the supply chain management market changes between 2020 and 2030, by solution type:

Major competitive or other industry participants include:

• Epicor Software

• HighJump

• Info

• IBM

• JDA Software Group

• Kinaxis

• e2open

• Oracle

• SAP

• Manhattan Associates

• Others

DSGX’ Recent Financial Performance

• Total revenue by quarter has risen according to the following chart:

• Gross profit margin by quarter has remained steady in the high 70s:

• Selling, G&A expenses as a percentage of total revenue by quarter have remained flat, as the chart shows below:

• Operating income by quarter has risen markedly in recent quarters:

• Earnings per share (Diluted) have followed the trajectory in the chart below:

(All data in above charts is GAAP)

In the past 12 months, DSGX’s stock price has fallen 19.2% vs. the U.S. S&P 500 index’ drop of around 15%, as the chart below indicates:

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 ( MANH ). Shown below is a comparison of their primary valuation metrics:

(Source - Seeking Alpha)

A full comparison of the two companies’ performance metrics may be viewed here .

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth/EBITDA trajectory.

DSGX’s most recent GAAP Rule of 40 calculation was 61.3% as of FQ2 2023, so the firm has performed well in this regard, per the table below:

(Source - Seeking Alpha)

Commentary On Descartes Systems

In its last earnings call ( Source - Seeking Alpha), covering FQ2 2023’s results, management highlighted the growth in revenue and adjusted EBITDA despite foreign exchange headwinds due to the strong US dollar.

The company's supply chain offerings have been in particular demand due to supply chain problems associated with the pandemic and continuing lockdowns in Asia.

Demand for its optimization solutions has typically risen when fuel costs rise and macroeconomic conditions worsen, as companies seek to increase business efficiencies to offset these challenges.

Notably, DSGX has acquired 3 - 4 businesses per year on average, and has the resources to continue to make selective acquisitions ahead.

As to its financial results, revenue rose by 18% year-over-year, as did adjusted EBITDA.

Management did not disclose any company retention rate metrics, but did say that it was investing more in the customer success function to improve its retention results.

DSGX’s Rule of 40 results have been impressive, with a recent result of 61.3%.

However, operating expenses rose 20%, due to the impact of recent acquisitions and from additional headcount.

Adjusted EBITDA grew by 20% year-over-year, while EPS matched FQ2 2022’s figure of $0.27 per share.

For the balance sheet, the firm finished the quarter with $189 million in cash and equivalents and no debt.

Over the trailing twelve months, free cash flow was an impressive $174 million, with only $5.7 million in capital expenditures.

Looking ahead, for full-year fiscal 2023, management believes there will be continuing foreign exchange headwinds and fallout from the Russian Ukraine conflict, but did not provide guidance for the full year.

Regarding valuation, the market is currently valuing DSGX over 25% higher than competitor Manhattan Associates, possibly due to its higher topline growth rate and net income margin performance.

The primary risk to the company’s outlook is a global macroeconomic slowdown in 2023 which would impact transaction volumes and hurt revenue growth.

An upside catalyst would include the U.S. Federal Reserve reducing interest rate hikes or pausing them entirely, leading to a lower cost of capital assumption and potentially higher multiple for the stock.

However, given foreign exchange headwinds and the increasing likelihood of an imminent recession (if we aren’t in one already), as well as management declining to provide full year forward guidance, I’m more cautious on the outlook for DSGX.

Accordingly, while the company may indeed thrive during times of supply chain turmoil, my outlook on DSGX for the near term is a Hold.

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