If you’ve been with us for some time, you probably know that we listen when members tell us something.
For the better part of a year now, we’ve had a lot of requests to do a feature on what we feel are the best opportunities on our Bull List today.
So, we’ve decided to do just that. Although it is technically the second Sunday of September, we’ll send this out on the first Sunday of every month.
It will highlight some of the better long-term opportunities we see on our lists at that time. Of course, ensuring a company fits into your overall risk tolerance and the mold of your portfolio is always essential.
The companies could be on our Foundational Stock lists, Growth Bull List, or Dividend Bull List. And with that, let’s get right into our first edition.
Alphabet (GOOG)
We all know that technology has been among the hardest-hit sectors in the market. Not surprisingly, valuations got out of control, and with rising rates, it suddenly became more expensive to grow.
That said, it doesn’t mean companies can’t grow and it certainly doesn’t mean that all tech companies are in the same boat.
Instead of chasing small caps, we like to focus on strong, profitable companies that have been unfairly ‘thrown out with the bathwater’ so to speak. Alphabet is one such company. Year to date, one of the largest tech companies on the planet has lost 22% of its value and at today’s price of $111.78, is trading near 52-week lows of $102.21 per share.
We believe the current price represents an excellent opportunity for investors to accumulate. While most high-flying tech companies are not profitable or cash flow positive, Alphabet is both and has been for years.
The company is expected to grow earnings by approximately 15% annually over the next few years and cash flow per share is expected to grow by 24% over the next year. These are impressive growth rates and with a forward PE of only 18.74, the company is attractively valued.
Can the company achieve these expected growth rates? We don’t see why not. Alphabet has an excellent track record as it has beat on the top and bottom lines 70% of the time over the past few years, and with Google and Youtube having such a dominant online presence, cash flows become a lot easier to predict.
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At 20x earnings and 23x free cash flow, it is the cheapest the company has been ever since it achieved consistent profitability back in 2014 (have a look at the chart above.)
With the company’s strong brand power, arguably the largest economic moat out of all the tech companies, and the ability for it to put up such consistent results, we view Alphabet as a strong opportunity on our US Foundational list right now.
Park Lawn (PLC)
This company seems to be an enigma. A comment in our Discord was made to the effect that when the markets are green, Park Lawn tends to be red and when the markets are red, it is green. While it may ‘feel’ this way, Park Lawns’ performance over this bear market says otherwise.
As a high-growth company, particularly one that grows through acquisitions, it has lost 33% of its value so far this year. We know the reason (high-interest rates), so we won’t go into that why again.
The other factor playing into weakness and company volatility is the fact that Park Lawn is a small-cap. Even though it trades on the TSX Index, Park Lawn is still considered a small cap which is far more vulnerable in a bear market. Finally, mortality rates have normalized as the pandemic normalizes and this has impacted operations.
That said, Park Lawn is different than many of its small-cap peers as it is profitable and generates positive cash flows. While earnings are expected to dip in Fiscal 2022 (due to the aforementioned mortality rate decline due to fewer people dying due to the pandemic), they are due for a rebound in Fiscal 2023. On the flip side, revenue is still expected to stay strong with double-digit growth in both Fiscal 2022 and Fiscal 2023.
Park Lawn is also a disciplined acquirer as each acquisition must be accretive and meet its targeted adjusted EBITDA margins. The company usually makes acquisitions through debt and cash on hand, so while rising interest rates may impact future acquisitions, we don’t think it will have a huge impact since the company is more so focused on smaller tuck-in acquisitions.
From a discounted cash flow perspective, this one is a little difficult to value simply because of its previous share dilution. However, it has certainly slowed as of late, diluting around 17%~ since 2019. If we assume low, single-digit share dilution for acquisitions over the next 4 years, we feel there is a double-digit margin of safety at these levels. One sub-par quarter doesn’t change an investment thesis. So, we will let emotional investors sell out of their positions, and we will simply accumulate.
Of note, Park Lawn is hosting their investor day on September 29 and which point we’ll likely get some insight into their outlook for the coming years.
You can view our full report on Park Lawn here
Open Text (OTEX)
Before announcing the MicroFocus acquisition, Open Text was outperforming the S&P/TSX Information Technology Index. While it was still down double-digits YTD, it was holding up better than most. This is largely because Open Text is one of the few tech companies that pay a sustainable, growing dividend.
We’ve talked about this many times before, it has the longest dividend growth streak among all TSX-listed tech companies. When this transformational acquisition was announced, Open Text’s share price cratered. The company has lost almost 20% of its value and hit a 52-week low of $38.12 per share.
It is interesting to watch investor mentalities during different types of markets. It is highly likely that if Open Text were to have made this acquisition during the market euphoria of 2020/2021, the market would have reacted positively. But now, investors can only think of worst-case scenarios. We must remove emotions from our investment decisions.
While it is tough to watch, these types of one-time events where investors overreact and make emotional decisions make for excellent buying opportunities. At issue, the company is taking on a large portion of debt ($4.6B) to make the acquisition and Open Text’s debt to adjusted EBITDA ratio will climb to 3.8x – one of the highest in its history. MicroFocus also had declining revenue.
However, what the market overlooks is that the company has made big splashes before and each time has successfully made use of its strong cash flows to reduce leverage back to targeted levels which in Open Text’s case, is below 3x. The company expects to achieve this within 8 quarters of closing, thanks to the fact the combined entity will be generating ~$1.2B in free cash flow annually.
Open Text is also confident that it can leverage the MicroFocus’ current client base which has many high-value businesses and will enable it to scale internationally. Of note, the deal increases Open Text’s European footprint by 50% and the Asian-Pacific and Japan footprint by 100%.
All this said, there is a certain ‘leap of faith’ required here. As with any large acquisition, success will ultimately be defined by the company’s ability to integrate MicroFocus into operations. That said, as mentioned Open Text has made several large-scale acquisitions and thus far, has successfully integrated each one.
If you haven’t already, we highly recommend you read this presentation:
It gives you all the highlights of the acquisition, explains the strategic importance of MicroFocus, and given the company has provided clear and details financial targets, investors can track their progress against said targets post-acquisition.
Bottom line, Open Text is one of the best serial acquirers in the business and we think that the current price drop is overdone. Of note, Mat picked up additional shares of Open Text on the current downtrend.
You can view our full report on Open Text here
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