A high quality opportunity off its highs
With speculative asset classes falling off a cliff, loss-making US tech darlings copping a beating and COVID-19 beneficiaries struggling to comp the comp – pockets of the equity market have been sold off aggressively over recent months. Broad-based sell offs are always good for fundamental stock pickers, as high-quality gems can get caught up in the fear and present themselves at meaningful discounts.
A perceived COVID-19 beneficiary that has exposure to the global technology industry and has sold off nearly 30% from its recent highs is under the radar Aussie small-cap Dicker Data (ASX:DDR).
Dicker Data is not the high-flying glamorous tech company that continuously burns cash with the future ‘promise’ of one day being profitable … it is quite the opposite. Dicker Data has been in business since 1978 (yes, that is before the first PC was even released). With 43 years of operational experience, they have consistently adapted to the changing technology landscape and since listing on the ASX in 2011, revenues have grown circa seven times to $2 billion, and profits by circa 13 times.
So what does Dicker Data do and why is there an opportunity?
Dicker Data is an IT Distributor, who sells IT hardware and software products on behalf of global vendors to IT resellers who service the small business, enterprise and government markets. They are the leading distributor in the Australian commercial market with 29% market share.
With the COVID-19 induced work from home phenomena, the demand for hardware and software from businesses to facilitate their employees to work from home surged through the first half of 2020. Fast forward 12 months, demand has stayed elevated but supply has been constrained due to global chip shortages. No one has supply which means this demand is backlogged (not lost) and should flow through to company earnings over the remainder of the year. The lack of supply means there is no need to discount, so margins have improved short term offsetting the revenue headwind.
The perception that earnings may go backwards this year due to prior year COVID-19 bump are unfounded as in addition to the continued demand for work from home, enterprise and government digital transformation spend (we estimate to be >50% of the DDR's business) was significantly depressed during Covid due to budgets being put on hold during the initial uncertainty of Covid.
Importantly enterprise spending has begun to pick back up and this should contribute to a strong second half of the year.
At current, there is a period of flux in the perception of Dicker Data’s business value, due to the uncertainties around being a perceived Covid beneficiary as well as its supply chain suffering from global chip shortages. However, we believe this is creating an opportunity to buy a high quality business at an attractive price. Totus has recently capitalised on this share price weakness and added to our position.
DDR ticks a lot of our boxes:
1. A long term track record of success
Dicker Data has generated a 19% Revenue CAGR and 26% Profit Before Tax CAGR since June 2010.
2. Returns demonstrating the strength of a competitive advantage
DDR has consistently generated high returns on equity, averaging 38% over the last 10 years.
Note: CY20 returns were diluted due to the investment in a new warehouse, which increases their capacity by 60%, we expect these to return to above the historical average as the new warehouse fills its capacity and also signals managements future ambitions for growth.
DDR benefits from typical scale economies, allowing it to compete on price with other global distributors such as Ingram Micro and Synnex. However, it differentiates against its competitors through its value-added service, driven by its technical expertise and performance based culture.
These intangible qualities are difficult to quantify but the following points reinforce our confidence in their competitive position:
#1 Increasing market share and stable gross margins
- This evidences the value they are providing their customers without the need to discount on margin to win business, in what could be seen as a commoditised industry.
- Multiple channel checks (customers and vendors) confirm the technical expertise and support provided is key to their success, especially with the increasingly complex digital landscape.
- Signals industry-leading expertise and reduces vendor concentration risk.
3. Owner-operator culture
Dicker Data was founded by David Dicker, who is the current Executive Chairman and CEO, and still owns 35% of the company. His ex-wife Fiona Brown is a non-executive director and is a long-term shareholder, owning 32%.
The rest of the board (including the COO and CFO) all have meaningful shareholdings, totalling about $14 million. The key management personnel (KMPs) are aligned with shareholders through their equity stakes and a meaningful variable remuneration component which is based on profitability metrics.
A testament to their conviction in the long-term success of the business is that the KMPs have not been issued shares or options and have built their equity stakes by buying shares on market (buying as recently as April 2021 at levels above $10 per share).
4. Industry Tailwinds
Microsoft’s CEO Satya Nadella recently stated that:
“As a percentage of GDP, tech spend is 5%. We think it will double in the next ten years…this pandemic perhaps has accelerated that doubling”.
Dicker Data has successfully capitalised on the industry growth in the past and are even better positioned to continue to capitalise.
Some key drivers over the medium term should include;
- Working from home/working from anywhere
- Digital transformation for large enterprise and small business
- 5G and Internet of Things through the proliferation of connected devices in "smart" offices and homes
- The restart of Covid delayed enterprise spending on IT projects
5. Attractive Valuation
At the current price of $9.40, you are buying a high-quality business on a forward PE multiple of less than 25 times that has a proven track record of success. You will get paid a 4% fully franked dividend whilst you back a shareholder aligned management team to capitalise on multiple industry tailwinds to compound their own and shareholders wealth.
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Tim joined Totus Capital in 2019, having previously worked at Centennial Asset Management as an analyst, focusing on ASX small and micro-cap companies. Tim holds a Bachelor of Chemical Engineering (Honours Class I and the University Medal) degree...