2023-11-27 13:42:43 ET
Summary
- DSGR announced Q3 FY23 results with a 26.4% rise in revenue, driven by acquisitions and increased revenues in the Lawson segment.
- Despite solid revenue growth, the company faces softness in the technology market and potential challenges in integrating the recently acquired HISCO.
- Technical analysis suggests resistance levels and a lack of buying opportunities, leading to a hold rating on DSGR.
Distribution Solutions Group ( DSGR ) is a specialty distribution company. DSGR recently announced the Q3 FY23 results, and I will analyze them in this report. It managed to grow its revenue when there was a softness in its TestEquity business. To tackle the situation, it has acquired HISCO, a leading distributor serving the industrial technology market. However, despite the solid growth in revenues, I assign a hold rating on DSGR, and I will discuss the reasons for my hold rating.
Financial Analysis
DSGR recently announced Q3 FY23 results . The revenue for Q3 FY23 was $438.9 million, a rise of 26.4% compared to Q3 FY22. The major reason for the rise was revenues from the acquisitions and increased revenues in its Lawson segment. The acquisitions contributed $106.3 million in revenue, and the revenue from the Lawson segment grew by 4.6% in Q3 FY23 compared to Q3 FY22. The major reason for the Lawson segment's revenue increase was a solid performance in its government military and Kent automotive business. Its adjusted EBITDA margin was unchanged in Q3 FY23 compared to Q3 FY22. The EBITDA margin in Q3 FY23 was 10%.
The net loss for Q3 FY23 was $1.5 million compared to a net income of $16.5 million. The acquisition and merger-related costs, which are non-recurring, affected its profitability. The organic revenue in Q3 FY23 was down by 4.2% compared to Q3 FY22. Still, the company managed to grow its revenues by making aggressive acquisitions. However, currently, there is a softness in the technology end market, especially in the capital equipment and test and measurement equipment market. This softness can hamper its revenue growth in the coming quarters, but to tackle this situation, it has recently acquired HISCO , which is one of the leading distributors that serves the industrial technology market. Although the HISCO acquisition is quite new, it will be interesting to see how the integration goes.
Technical Analysis
DSGR is trading at $26.8. In October, it gave a breakout above the $30.5 level, which was also its all-time high back then. But soon after giving the breakout, the stock reversed, proving to be the classic case of a breakout trap. After the breakout, the stock started to reverse, and it quickly went below $25. I believe investing in DSGR right now might not be a good idea because there are currently too many resistance levels like $28, $30, and $32, which the stock price might face. So, investing at the current level might get your money stuck for a long time without any returns. So, I think creating any fresh buying position in this stock might not be rewarding. Hence, I assign a hold rating on DSGR.
Should One Invest In DSGR?
One of the major strategies to boost their revenue growth is acquisitions, and they are proving beneficial for them in times of softness in the market. It will be interesting to see how its HISCO acquisition turns out because there is a softness in the industrial technology market, which might hamper its growth in the coming quarters, and if the integration is successful, then the company might be able to negate the softness issue in the industrial technology market to some extent. Now, looking at its valuation. DSGR is trading at a non-GAAP P/E [FWD] ratio of 33x, which is above its five-year average of 21.73x. So, the market has rewarded DSGR with a high valuation, and I believe the high growth that it has shown recently during not the best market conditions was impressive. When a company shows high growth, the market often rewards it with high valuation. But despite the high growth that it has shown, I think now is not the right time to invest in it, and there are some reasons behind it. First, the softness in the industrial technology market might hamper its growth in the coming quarters, and the acquisition of HISCO is new, so it might take some time to execute the operations that the company has planned successfully. The second reason is the technical chart of DSGR. Its technical chart does not provide any opportunity. Instead, the chart suggests that it is better to avoid it. Hence, I believe one should wait for some time and let the market conditions improve. Hence, I assign a hold rating on DSGR.
Risk
1) The Company's net operating loss carryforwards as of December 31, 2022, were $24.2 million from the federal government of the United States, which will expire in 2026, and $28.7 million from various states, which will expire at different times between 2023 and 2034. Due to the Mergers, DSG may have fewer options for using its net operating losses and other tax attributes created before the Mergers. This might have a negative effect on their cash flow and future tax burden.
2) For a sizable portion of its product inventory, including electronic test and measurement equipment, TestEquity is dependent on a single source. The total amount of product inventory that TestEquity purchased from that supplier in 2022 and 2021 was roughly 25% and 41% of the total amount of product inventory that TestEquity purchased from all of its suppliers during those years. Any alterations to the supplier's operations, financial status, or business could significantly negatively impact TestEquity's operations, financial standing, and operational outcomes.
Bottom Line
Their acquisition strategy is paying off during times when there is softness in the market. DSGR has been trading over the historical averages, which I believe is due to the high growth they have shown. However, I assign a hold rating on DSGR as there is a softness in the industrial technology market, and its technical chart shows that the stock price might be stuck in a range.
For further details see:
Distribution Solutions Group: No Buying Opportunity Despite High Growth (Technical Analysis)