Tech investors were vindicated this year. The ongoing tech rally has added billions to the valuations of Canada’s software companies. Large-cap tech stocks have dominated this bull market cycle, but even niche small caps have benefitted.
European software conglomerate Topicus (TSXV:TOI) is an excellent example. The stock is up 48.11% year to date. This rally was backed by robust fundamentals, as Topicus delivered steady growth in revenue and cash flow. But has the rebound run out of steam? Can Topicus keep growing at this pace? Here’s a closer look.
Fundamental growth
Topicus is focused on a growth-via-acquisition strategy in Europe’s fragmented enterprise software market. That means its ability to buy and integrate small software companies at a steady pace determines its growth rate.
Higher interest rates across Europe have lowered the valuation of tech companies, so Topicus might have attractive targets on its radar. Meanwhile, the team has been shedding debt. As of March 31, 2023, Topicus had cut its net debt down to just €5.7 million (CA$8.24 million). Cash was up to €197 million (CA$284 million).
Simply put, Topicus has enough cash to fund its acquisitions for the foreseeable future and doesn’t have to worry about higher rates impacting its cash flow.
In its most recent quarter, the company delivered revenue growth of 30%. Free cash flow available to common shareholders, meanwhile, was up a whopping 65%! I expect this trend to continue now that the company has reduced leverage.
Valuation
Topcius stock has rallied 45% this year, but it’s still 21% lower than its 2021 peak. The company’s market cap is $8.9 billion. The company deliver €916 million (CA$1.3 billion) in revenue last year. That means the stock is trading at a trailing price-to-revenue ratio of 6.8, which is perfectly fair for a profitable software company with double-digit growth.
For comparison, most enterprise software companies trade at price-to-sales ratios closer to 10, even if they’re unprofitable. Topicus, meanwhile, was cash flow positive. Annualizing its recent quarterly free cash flow statement, the company could be on track to generate roughly $580-$600 million in free cash flow this year. This means the stock is trading at a price-to-free cash flow ratio of 15.
Bottom line
Topicus has proved its business model. The European software market is ripe for consolidation, and Topicus is perfectly positioned for this wave. The company has enough cash to field these acquisitions, and its debt burden has been lowered enough to reduce risk. It also has the skills and resources needed to successfully integrate these new acquisitions and boost earnings over time.
Meanwhile, the stock trades at just seven times sales and 15 times free cash flow. It’s an undervalued growth opportunity that has plenty of room to run. Keep an eye on it.
