Robert McWhirter Enghouse Systems ENGH-T COMMENT May 17, 2019

Small caps get whacked when interest rates rise. If investment-grade companies borrow at 6%, small caps borrow at 10%. Russell 2000 rallied after the election, and has fallen ~8% in December. ENGH has no debt. Strong FCF, dividend grows 15-20% every year.

Q4 earnings were a bit light, so stock's fallen. They also made 2 acquisitions in the quarter. With small caps, you have to be patient. Yield is 3.87%, almost unheard of for a small-cap stock. Switching business model to SaaS, which should improve margins over time and you'll eventually get increased profitability. Stock's at a new 52-week low, and he's buying.

He owned it when they were a typical Canadian compounder, reinvesting cash into tuck-ins, but it became lumpy. That's when he sold. They spiked during Covid, because they had a telehealth business, so YOY comps later didn't look good. Also, how does AI impact their large call centre business?

His 12-month target is $37, today it's at $27, so still a bit to go. Builds its business around acquisitions, both vertically and horizontally. Not in his fund, but in separately managed accounts. More of a trade than an investment.

On his radar because it's a cheap software business, with high margins and recurring revenue. Lower valuation than CSU, but not as effective at consolidating. Disappointing results, organic growth weak, slower M&A. Strong balance sheet. Good insider ownership.

All his past picks on this date were small-caps and chosen, based on him expecting US interest rates to fall. All were turnaround plays. He used dollar-cost averaging. Fading interest in small-caps now, but he still likes ENGH. They are a serial buyer of private companies at good prices. Margins are rising so are increasing the dividend to 4.5%. But they're not large nor liquid. Is adding at these levels.

A mini-CSU, because they have built by strategic acquisition well. It hasn't excelled like CSU, because they haven't scaled their business yet. He targets $36.50.

Not getting much love in the market. Cheaper than almost anything out there, yet keeps getting cheaper. Holding massive amount of excess cash; not using it to increase dividend or buy back shares, so it's in the penalty box. Value tends not to work in tech.

So much other great stuff out there now at reasonable prices.

Essentially an 18% dividend increase every year. Taking on the MSFT business model for SaaS, as subscriptions smooth out margins from quarter to quarter. Recent acquisition announcement raised stock. Growing margins. Asset light, little debt. He likes these serial acquirers. 

ROIC is 15%, WACC is 8.5%. That means a ton of free cashflow to make acquisitions, pay off debt, rinse & repeat. It's a small cap now, and he anticipates it growing and gaining attention.

Small cap. Earnings coming out June 5, 3 days away. Usually when a company raises dividend by 18%, the expectation is that profits will grow by that much (though he can't speculate). Climbing back since April lows. Margins are good and getting better. Revenues are starting to grow again since Covid. Yield is 4.5%.

He has it in TFSAs, RESPs, and accumulates more over time.

Management has had lots of success with prior companies, but has struggled with growth at ENGH. In its early days, there was a premium for management, and without growth as expected this impacted the valuation and the stock's returns over time. 10-year return is now negative. We do not know why the company has been so reluctant to spend its cash. It has had too much cash for far too long. A growth acquisition would be a good catalyst, certainly. Insiders do own 22%. The share count has not changed much but it has not gone down significantly with buybacks, either. The tech sector of course has been very strong, but its particular niche has been less robust. ENGH is focused and is proud of its profitability record, so its less-aggressive growth stance has kept it a laggard versus faster-growing peers (who may be unprofitable). We think it is OK, but now it is more OK for income. A takeover/privatization may be possible as we are sure management is just as frustrated as public shareholders. We think in tech CLS looks better, as do the CSU group of companies (CSU, TOI, LMN).
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