OpenText (TSX:OTEX) stock has fallen 37% in five months. This is the steepest dip since the 2022 tech meltdown, when the stock fell 46% from September 2021 to September 2022. The stock is now trading at around $40. Is this the time to buy the dip or run for cover?
Is OpenText stock buying the dip?
The latest dip comes as OpenText reduced its fiscal 2024 outlook for adjusted earnings before interest, taxes, depreciation, and amortization margin from 36%-37% to 33.5%-34.5%. It even reduced its free cash flow outlook from US$825 million-US$900 million to US$725 million-US$800 million. The dip in guidance reflects the exclusion of its cash-rich mainframe business, AMC.
If you look at OpenText fundamentals from a long-term perspective, the market seems to have overreacted to the reduction in guidance. The company has several bull cases that make the stock a buy the dip.
The bull case of OpenText
OpenText is an information management cloud solutions provider that helps customers simplify their systems, connect their data, and improve the efficiency of their operations on the cloud. The company has been transitioning its information management solutions from mainframe to private cloud. The Micro Focus acquisition and AMC divestiture is a part of its cloud-focused strategy.
AMC is a slow-growth business. By divesting it, OpenText has freed up space for fast-growing cloud business. It aims to grow its revenue organically by 2-4% by targeting enterprise cloud customers and increasing annual recurring revenue. The company is also open to growing through acquisitions. Its acquisition target will be mainly small- to medium-sized cloud information management companies with high recurring revenue.
It plans to grow its free cash flow from US$725 million in fiscal 2024 to US$1.2 billion in fiscal 2027 by reducing interest expenses and special charges and integrating Micro Focus. This is the lower end of its guided range and represents an 18% average annual growth. The company intends to use half of this free cash flow in share buyback and dividends and another half in mergers and acquisitions.
The reduced guidance of FY24 is a temporary dip and does not impact its future acquisition prospects and dividend growth.
Is the stock undervalued?
In the nine months of fiscal 2024, OpenText’s revenue surged 47%, and earnings per share (EPS) surged 33.5%, hinting at a growing business. Despite a strong growth rate, its stock is trading at 1.4 times its sales per share and 8.37 times its forward EPS. The stock seems undervalued compared to its growth potential.
Now is a good time to buy the stock as the company’s shares are trading closer to its 52-week low.
OpenText has been growing its dividend over the last 10 years at a compounded annual growth rate of 11%. Buying the dip will allow you to lock in a 3.3% dividend yield and a 38% capital appreciation as the stock recovers to its normal trading price of around $55.
