The 2022 tech wreck is severely punishing companies. It is especially unforgiving for forms that have strong revenue growth but no profits. By comparison, companies with decent double-digit percentage revenue growth and modest profits are not down as much. However, the market’s unwillingness to overpay for technology stocks will hurt its upside potential. Descartes Systems (NASDAQ:DSGX) is one such example.
Descartes earned 27 cents a share after growing its revenue by 17.6% Y/Y to $123 million. Service revenue accounted for most of that. It is generating positive cash flow and paying off its acquisition. Is this enough to justify buying DSGX stock from here?
Descartes posted service revenue of $212.2 million, which accounted for 89% of its total revenue. Cash from operating activities of $90.8 million allowed it to pay $10.5 million related to its previously completed acquisitions. In its Adjusted EBITDA table, the company did not report any alarming expenses. For example, it recorded stock-based compensation of only $3.8 million. Amortization of intangible assets and income tax expenses accounted for more:
Investors would benefit from looking for positive catalysts that might suggest an upside in the upcoming quarter.
On the conference call, Chief Executive Officer Edward Ryan said that customers recognize the economic uncertainties ahead. Fortunately, Descartes has strong support from its customer base. They view investments in the supply chain and logistics as a requirement. This suggests that they will continue to keep investment levels at the same levels at a minimum.
The company reported that recurring revenue accounted for 40% of total revenue. This will give Descartes a sufficient cushion as the economy wanes. Shipping volumes likely peaked at record levels. As shipping rates fall and suppliers adjust for lower demand, Descartes customers will re-evaluate their logistics investments.
The shipping backlog is still an issue that retailers must manage. They will need Descartes to help them manage the ongoing backlog levels. In addition, the backlog among all transportation modes – rail, air, and ocean – remains. Even though shipping stocks fell and Maersk warned of “dark clouds on the horizon,” investors should not panic sell DSGX stock.
Descartes has around 40% of its business dependent on transaction volumes. In the past, CEO Ryan said that the recession lowered transaction volume by around 8%. At the time, the world still needed to transport goods. This lightly hurts its growth rate in that worst-case scenario.
Investments and Acquisitions
Descartes is prioritizing investing back in the business. In the last year, its investments resulted in strong EBITDA margins of 43.9%. Organic growth also helped results.
Unless it finds an acquisition target valued at a steep discount, investors should not expect the company to buy a firm. It will benefit instead in keeping its $189 million in cash on the balance sheet. Should it find a buyout opportunity, it has $350 million undrawn from its line of credit and has no debt.
Descartes investors are worried about the macroeconomic risks. However, the US posted a positive GDP of 2.6% annualized in the third quarter of 2022. Recently, the stock pulled back from its rally that began in May through August. It reacted because the central banks are raising rates to induce a short-term recession.
Next month, when the Federal Reserve raises rates again, it will likely slow the pace of rate hikes. Although it will not pivot to rate cuts, the smaller rate cut will help the economy recover in the next few quarters.
Conservative investors seeking technology exposure should consider a position in Descartes Systems. It is focused on building a predictable and sustainable business. Markets will appreciate a firm that will report strong results regardless of the changing market conditions. Unlike young high-flying tech firms that broke down at the first sign of a slowdown, Descartes is resilient.
Seeking Alpha’s premium stock scoring system assigned an A+ to the company’s profitability and a B+ on growth. Still, the value score could improve. Investors may set a price alert for DSGX stock at $60 or lower.
$60 is the price at which the stock bounced off its low between April and June. The stock becomes a more compelling buy if the market offers it at a 10% discount.