2023-04-20 14:20:08 ET
Summary
- The CDW Corporation Q1 2023 pre-announcement reveals concerns about the impact of a weakening macroeconomic environment on the company's performance.
- Despite challenging conditions, CDW's diverse business model and competitive advantage position the company to potentially outperform the declining IT market.
- Investors should closely monitor CDW's cost alignment efforts, industry outlook updates, and potential wildcards that may impact projections.
In this article, we will delve into the recent CDW Corporation (CDW) Q1 2023 pre-announcement , which indicates potential headwinds due to an uncertain economic environment and cautious customer spending. While we acknowledge CDW's strong business model and competitive advantage, we believe the company is currently trading at a fair valuation in light of the increasing economic uncertainty. Consequently, we maintain a neutral stance on the stock. We will examine the factors contributing to this downturn, assess CDW's competitive advantage and business model, identify potential risks, and evaluate the company's current valuation.
Analysis of Negative Q1 Pre-Announcement
In our view, CDW Corporation's pre-announced Q1 2023 results are a cause for concern, as the company faces headwinds from the uncertain economic environment and cautious customer spending. CDW has added its name to the expanding list of Networking & Hardware firms negatively pre-announcing financial results for the upcoming earnings season. The company now expects revenue to be roughly $5.1 billion for 1Q23, implying a mid-single-digit decline sequentially, compared to the prior outlook of flat to low-single-digit growth.
Intensifying economic concerns have led to cautious spending and prioritization of mission-critical initiatives by their customers. Most notably, volume declines were observed in their largest commercial customers and across transactional products. As evidenced by TD Synnex's recent earnings print, CDW highlighted that the declines were weighted towards the largest commercial customers and "transactional" products. Although Solutions were more resilient, contributing to a strong gross margin performance in 1Q23, demand for these offerings also fell below expectations.
We believe that CDW now expects the U.S. IT market to decline at a high single-digit rate in 2023, a marked change from the previous expectation of a flat year-over-year (y/y) performance. Despite the challenging market conditions, CDW aims to outperform net sales by approximately 200 to 300 basis points y/y in constant currency. In our opinion, this suggests that CDW is confident in its ability to capture market share even in a declining market environment. The management remains confident in their strategy, diverse business model, and their team's ability to execute and gain market share.
Importantly, CDW now anticipates the more muted spending backdrop to persist beyond this quarter, revising down its full-year US IT spending forecast to a high-single-digit decline (vs. flat prior). However, the company expects earnings to be only "modestly below" 2022, likely driven by a higher margin mix and tighter cost controls.
From an investor's perspective, CDW's Q1 2023 results may be concerning, but it's worth noting the company's ability to maintain a diverse business model and its expectations to outperform the declining IT market. Investors should closely monitor the company's cost alignment efforts, industry outlook updates, and potential wildcards that may impact projections. Additionally, the overall IT market decline highlights the need for investors to stay informed about broader industry trends and potential opportunities in other segments or regions.
With demand likely taking a step down triggered by renewed and elevated macro concerns following recent banking challenges, we would not be surprised to see companies reporting later in the earnings season highlighting larger concerns in the form of subdued guidance relative to OEMs reporting earlier. In our view, CDW's resilience and confidence in outperforming the market amidst challenging conditions could signal potential investment opportunities, but caution and vigilance are advised.
Business Overview
Before investors can make an informed decision based on the company's pre-announcement, we believe it is crucial to take a step back to understand the bigger picture of the company's business and industry.
Based on our analysis, it is evident that CDW Corporation's balanced portfolio of end markets, along with the breadth and depth of its product offerings, have demonstrated the strength of the company's business model during the last three quarters. The macro-environment highlights the increasing importance of technology in driving strategic and mission outcomes for customers. Furthermore, the complexity of technology choices and the pressure to optimize add to the demand for expertise, good judgment, and guidance.
Our research indicates that CDW's value proposition is resonating with its customers and is more relevant than ever. Across diverse end markets, we observe several common trends. First, businesses are focusing on optimizing their infrastructure, including cloud strategies, to support the massive investment in endpoint devices. Second, digital transformation, encompassing digitization, automation, and productivity enhancement, is a priority for many organizations. Third, the hybrid workspace is driving a continued emphasis on collaboration tools. Lastly, security is a top concern across all industries.
Looking at specific segments, we find that commercial and small businesses share similar trends, with a focus on cloud, software, and security. The federal segment has returned to normal seasonality, with PC refreshes taking place. Healthcare, on the other hand, faces cost challenges and is increasingly open to cloud solutions to drive productivity. CDW's international segment, particularly the UK, has been performing well, despite the challenging environment, thanks to the company's strong execution.
In our view, CDW's ability to pivot and adapt to market opportunities while maintaining its strong execution capabilities is a testament to its resilience. The company's value proposition, coupled with its broad and diverse portfolio, enables it to navigate the ever-evolving technology landscape effectively. Consequently, CDW is well-positioned to capitalize on the trends impacting various industries and continue to thrive in the current market environment.
The CDW Competitive Advantage
We believe that CDW Corporation possesses a significant competitive advantage in the rapidly evolving technology market. This advantage stems from the company's ability to adapt its offerings and expertise to meet the changing needs of customers who increasingly focus on achieving specific business or mission outcomes.
CDW's primary differentiator lies in its high-performing expert team, which is capable of navigating the complex technology landscape and providing customers with the best options to optimize their desired outcomes. As customers seek comprehensive solutions rather than isolated products, CDW's expertise in multi-stack solutions that encompass software, cloud, services, and hardware components gives the company an edge over competitors.
In response to the shifting expectations of customers, CDW has been investing in technical capabilities and refining its sales processes to engage in outcome-focused conversations. This approach enables CDW to provide tailored solutions that not only meet customer requirements but also create lasting value. For instance, the company can offer advice on workforce collaboration, productivity, endpoint solutions, and digital experience, along with the necessary supporting infrastructure, rather than simply selling hardware.
CDW's cost structure, which includes a level of variable costs associated with sellers, allows the company to remain agile in response to market fluctuations. Additionally, the focus on driving higher-margin products and services while bringing in technologists to expand the company's capabilities serves to offset associated costs. This strategy ensures that CDW maintains strong profitability while delivering added value to its customers.
Risks
We have identified several risks associated with owning shares of CDW Corporation, which investors should consider before making any investment decisions.
Firstly, the rapid migration to cloud computing presents a potential risk to CDW's current business model. As public cloud computing demand increases, it could disrupt the company's established position in the market and affect its ability to provide comprehensive technology solutions. CDW would need to adapt quickly to the evolving cloud landscape and ensure that its offerings remain relevant and competitive.
Another risk factor is pricing pressure from original equipment manufacturers (OEMs). Should OEMs decide to shift back to a more direct sales model or reduce rebates, CDW's profit margins may be adversely affected. In such a scenario, the company would need to identify alternative ways to maintain profitability while ensuring that it continues to deliver value to its customers.
Finally, the threat of competition, both from new entrants and existing competitors, could lead to depressed margins as a result of intensified rivalry. CDW must continually invest in its capabilities, expertise, and product offerings to maintain its competitive edge and differentiate itself from other players in the market. The company's ability to navigate an increasingly competitive landscape is crucial to its long-term success and, consequently, the performance of its shares.
Valuation
In recent years, CDW Corporation has demonstrated strong growth, with its revenue increasing from $15.2 billion to $23.7 billion. This impressive performance has been accompanied by an improvement in gross margin, which is expected to reach 20.4% in 2023, up from 16.7% in 2018. The company's operating margin is also projected to rise to 8.8% in 2023 from 7.5% in 2017. These positive developments have been driven by CDW's focus on value-added services and achieving scale.
However, it is worth noting that 2023 may be a challenging year for the company. Current consensus estimates suggest a 4% decline in revenue for the year, and this figure may further decrease considering that some estimates may not yet be adjusted for the recent pre-announcement. Furthermore, earnings per share are expected to decline by 2% in 2023, which may be overly optimistic given the company's recent Q1 results.
CDW is currently trading at 16.6 times forward 12-month consensus EPS, which is within the lower end of its five-year range, excluding the abnormally impacted period in March 2020 due to COVID-19. This lower valuation is indicative of the market's concerns about the weakening macroeconomic environment.
Based on our analysis and due diligence, we concur with the market's assessment of the challenges CDW may face in the coming year. As a result, we maintain a neutral stance on the stock.
Conclusion
In light of the CDW Corporation Q1 2023 pre-announcement and the challenging market conditions, it is crucial for investors to recognize the company's ability to maintain a diverse business model and its expectations to outperform the declining IT market. However, despite CDW Corporation's resilience and confidence in outperforming the market amidst challenging conditions, we believe that the company is trading at a fair valuation, as it faces increasing economic uncertainty.
As a result, we remain neutral on CDW Corporation stock. Investors should closely monitor CDW's cost alignment efforts, industry outlook updates, and potential wildcards that may impact projections while staying informed about broader industry trends and potential investment opportunities in other segments or regions.
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CDW Corporation Stumbles Amid Challenging Market Conditions