It’s been almost three months since I last visited CDW Corporation (CDW). I was bullish on the shares at the time, and since then, the shares have rocketed up by 21%, thereby validating my investment thesis. The shares are still down, however, by 5% since the start of the year. While challenges still remain for the company, I show why I believe the stock remains an attractive buy for long-term investors, so let’s get started.
A Look Into CDW
CDW is a leading multi-brand technology solutions provider to businesses, government, education, and healthcare customers. It is ranked as #178 on the Fortune 500 list, and operates in the U.S., Canada, and the UK. It currently employs over 10,000 people, and last year, had $18 billion in total revenues. Many corporate employees may recognize the CDW brand for the hardware equipment and accessories that they provide, such as laptops and monitors. But beyond these services, CDW also provides security, cloud, data center, and networking solutions.
What I like about CDW is its hugely diversified customer base. As an IT services provider to 250K customers, this makes the company less susceptible to any company- or industry-specific risk. Plus, it has over 100K products, services, and solutions from more than 1,000 vendor partners. In a sense, CDW can be seen as an industry and economic bellwether due to its size and the scope of its penetration into many industries.
This vast number of customer relationships enables CDW to have an economy of scale, with more than 250 public, private, and hybrid cloud offerings. This includes relationships with leading cloud providers, such as Microsoft’s (MSFT) Azure and Amazon’s (AMZN) AWS.
CDW reported solid Q3 results, with revenue rising up by 9% QoQ, and Non-GAAP EPS increasing by 17% QoQ, from $1.56 in Q2’19, to $1.83 in Q3’20. It should be noted, however, that CDW continues to face a challenging operating environment, as revenue was down by 3.1% YoY, as seen below.
(Source: Q3’20 Investor Presentation)
As seen in the above table, the corporate, small business, and UK & Canada (combined as ‘Other’) segments remains challenging, as many businesses are still adopting work-from-home practices. On the bright side, the public sector business, including government and education, showed resiliency, with a 9.2% YoY revenue increase.
In addition, CDW benefits from its diversified IT service offerings. This is supported by the 50% QoQ increase that CDW saw during Q3 for software-as-a-service solutions. Both cloud and security products showed strong growth, as many of CDW’s customers have adopted virtual work environments during the current pandemic. This growth was noted by management during the recent conference call:
Cloud customers spend increased double digits across all customer end markets driven by robust growth in security, collaboration, infrastructure as a service, and productivity. We expect strong customer demand for cloud solutions to continue with. Security also continues to be a top priority for customers. Security customers spend grew strong double digits this quarter as customers improve their security frameworks to respond to the increasing threats.”
I expect CDW’s cloud and security businesses to continue doing well in the near-term, as COVID infection rates have surged since October, and may remain at an elevated level as we head into the winter season. Longer-term, I expect CDW’s overall business to pick up in the second half of next year, when a vaccine becomes widely available. Speaking of which, I’m encouraged by the news on November 18th, noting a 95% effective rate for Pfizer’s (PFE) and BioNTech’s (BNTX) COVID-19 vaccine.
I also see CDW benefiting from its leadership position in a fragmented market across thousands of value-added resellers. According to management, CDW plus its next three largest competitors represent less than 10% of CDW’s U.S. addressable market, which has grown at an annual CAGR of 4.4% in the period from 2015 – 2020. As such, I see potential for CDW to growth both organically and through acquisitions. This is supported by CDW’s strong liquidity position of $2.2 billion, including $1.25B in cash, and close to $1B in available capacity on its revolving line of credit.
As seen below, CDW has had strong execution over the past decade (2010 – 2019), with a revenue CAGR of 8%, Non-GAAP operating income CAGR of 11%, and Net Income growing at a 30% CAGR. During the same period, management has deleveraged the company, from a net debt to EBITDA ratio of 3.2x in 2015, to just 1.8x in the latest quarter. This leverage ratio falls below the 2.5x level that I generally consider to be safe.
(Source: Fall/Winter Investor Presentation)
I also see management has being shareholder friendly. As seen below, total common shares outstanding have been reduced at a -3.4% CAGR since 2015, from 168.2M shares to 142.8M shares at present. Meanwhile, the dividend has grown at a fast clip. While the current dividend yield of 1.2% is not too impressive, it has grown impressively at a 5-year CAGR of 45%, and has a very safe payout ratio of just 25%.
(Created by author based on Seeking Alpha data)
Turning to valuation, I wanted to calculate a PEG ratio based on the following inputs:
- Price: $135.73
- EPS: $6.27 – based on the average 2020 analyst estimate.
- EPS Growth Rate: 14.4 – based on the more conservative 11% annual NOI growth over the past decade (versus the 30% net income growth rate), plus 3.4% share buyback rate. These figures can be found in the preceding section.
Based on the calculation above, I arrive at a PEG ratio of 1.50. While a PEG ratio of 1 is generally considered to be fair value, I use a range of 1.25 to 1.75 as my own estimate for fair value on well-established companies with strong track records. In the case of CDW, I assign a PEG ratio target of 1.6. This takes into consideration CDW’s leadership presence, strong track record and balance sheet, while also baking in near term uncertainties around COVID.
This implies a 7% upside (1.6 / 1.5), and a price target close to $145 per share. Analysts share a bullish sentiment on the stock, with a consensus Buy rating (score of 4 out of 5), and an average price target of $141.
CDW is a leading multi-brand technology solutions provider to businesses, government, education, and healthcare customers. The business has demonstrated its resiliency with strong revenue and EPS growth on a QoQ basis. While I expect continued challenges from COVID as we head into the winter season, I see CDW’s diversified business model as a big positive, especially as it leverages its cloud and security offerings in helping its customers adapt to virtual work environments.
I see CDW’s long-term growth thesis as being intact, through its leadership position in a fragmented market. This is supported by its strong track record of growth. While the share price has had a decent run over the past three months, I still see further upside from the current valuation. Buy for growth and meaningful future income, given the impressive dividend growth rate.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.