Valuation: Undervalued

Investment Thesis:

The COVID-19 pandemic has accelerated supply chain problems, from microchips to gas to wood pallets, the problems facing global supply chains are seemingly endless.
- Now more than ever, having a reliable supply chain is crucial for businesses to operate.
ePlus offers a suite of software designed to help businesses in all aspects of their operations, one of these operations would be their supply chains.
- ePlus can take advantage of the current global supply chain problems by helping customers fix their supply chain issues and winning new customers that would benefit from ePlus’ supply chain software.
  - If ePlus delivers a good enough product these customers are likely to remain with ePlus and generate recurring revenues.
- By following the investment plan (set out near the end of this report), an investment into ePlus is likely to yield a return between 8.98-12.21%.
  - However, there are risks with every investment, these risks are also highlighted later in this report.

Macroeconomic Outlook:

A simple google search of the following phrase “Supply Chain Shortage” yields over 3.65M results in a little over a quarter of a second. The headlines that come up from this search are very worrying and are not limited to a single industry (ie. Chips or semiconductors). Instead, we get a variety of headlines that read, “Semiconductor Shortage Shines Light on Weak Supply Chain” or, “Pallet Shortage Adds New Wrinkle to Pandemic Supply-Chain Issues” or, “Global Chip Shortages, Supply Chain Woes Leading to Tech Infrastructure Inflation” and finally, “Gas Shortage from Colonial Pipeline Shows a Fragile Supply Chain”. None of these headlines are from the same industry, product supply shortage, however they all have one underlying issue, which is their supply chains.

In an interview with Hank Canitz (VP of Nulogy (a supply chain software company)), he stated that,

“For years, the manufacturing industry has been focused on cost cutting and efficiency by implementing just-in-time manufacturing processes and operating with as few outside partners as possible while still meeting demands. The COVID-19 pandemic exposed how brittle global supply chains had become. Low cost and efficient supply chains have a difficult time responding to change and recovering from disruption. Although the effects of the pandemic only represent a small percentage of any global supply chain’s risk, the increase in demand and supply variability caused parts and materials shortages, shipping delays and rising costs. The pandemic was the final straw that broke many global supply chains making it extremely difficult for manufacturers to fulfil orders using the supply chain they currently had.”

With COVID-19 causing numerous supply chain shortages, there is an increasing imbalance between the levels of supply and demand for many manufactured products. This imbalance has been leading to drastic price increases and price gauging, the best examples of this come from toilet paper & hand sanitizer early on in the pandemic, the current inflation of lumber prices, and the absurd prices in the real estate market. As a result of this madness, supply chains and supply chain management have become very important, and in a recent study of the supply chain management, experts estimate that the supply chain management software industry will grow at a CAGR of 11% over the next 5 years, which highlights the importance and grow of this market post COVID-19.

All of these macroeconomic factors are favourable for companies like ePlus, who offer supply chain software solutions. Furthermore, knowing that ePlus invests and tries to stay in front of industry trends could be favourable if there is any news about them integrating blockchain technology into their supply chain software as this market is poised to grow at a CAGR of 81.7% between 2021-2026, however there is no news about this, and there are no indications currently that they are even contemplating it. However, it will not surprise me if they make an announcement that they would use blockchain technology as they are known to adapt and stay ahead of trends. One company and one crypto that use blockchain technologies in the supply chain are Treum (company), and Origintrail (cryptocurrency).

Sources:

Q&A: What's Causing Supply Chain Shortages, and How to Prevent Them | Manufacturing.net

The Global Supply Chain Management Software Market is (globenewswire.com)

Global Blockchain Supply Chain Market (2021 to 2026) - (globenewswire.com)

Company Overview:

ePlus is a leading solutions provider that delivers actionable outcomes to companies by using both IT and consulting services to help drive business innovations.

ePlus assesses, plans, delivers, and secures solutions that are compromised of leading technologies, consumptions models that align with their clients needs. ePlus is able to create optimized solutions to improve costs, scale, and efficiency of private, public, and hybrid clouds in today’s evolving market.

Furthermore, ePlus offers consulting, professional services, IT staff augmentation, and management services. Their management services include security, cloud, networking, data center, collaboration, and emerging technologies to help a business in all aspects.

ePlus understands their customers needs, and tailors their services in order to best design, deploy, and manage solutions that aligns with the needs expressed by their customers. The main goal of ePlus is to help their customers gain more control over their supply chains through optimizing/automizing the management of their assets.

ePlus has continuously re-invested into improving their technology and engineering resources to stay in front of emerging technology trends. ePlus aims to provide a unique customer experience, fast delivery of their services, and superior management and upkeep of their services.

ePlus’ market strategy is to target clients that are considered middle to large enterprises, who could benefit from using their software.

ePlus has broken their revenue by industry, and the results are as follows:

21% from the technology industry (12% of the total revenue was from Apple)
19% from telecommunications, media, and entertainment industries
16% from governments and educational institutions
15% from the healthcare industry
13% from the financial service industry.

Investment Information:

Financial Information:

Net sales have grown by 6.7%, and gross profit has grown by 9.9%.
- I will be using the 9.9% gross profit growth rate as the GAGR of the 1^st DCF model.
In 2020 ePlus increased their provision for credit losses by $1M, however their actual credit loss was only $429,000
- They beat their estimate by 57.57%.
Between 2019 and 2020 ePlus bought back 203793 shares at an average price of $70.79
- Bought back $14.426M in common shares
- This sends a bullish signal to investors because
  - ePlus believes that they were undervalued, hence the reason that they bought shares.
  - It takes shares off of the public markets meaning each share is worth slightly more of the company now than they would before. (opposite effect of share dilution)
  - Indicates that there is a possibility that they continue to do this in the future.
- Their Adjusted EBITDA grow rate over the past 4 years is 21.87%
  - Used this figure in the 2^nd DCF model.

Company Information:

In ePlus’ SEC filing they highlighted their competitive strengths. The most important of these strengths include:

Large addressable market with growth opportunities
- This will likely be drive by the increasing complexity of IT, and organizations will be pressured to deliver higher levels of service, and thus they will need multi-vendor solutions such as ePlus.
Broad and Diverse customer base across multiple markets.
- 3,500 customers across the globe, in various industries listed in the “company information” section.
Deep expertise in advanced technologies
- These include Cloud, Digital Infrastructure, and other emerging IT trends.
- ePlus focuses on obtaining and maintaining top-level engineering certificates and professional service expertise to help deliver their customers the most value.
  - ePlus currently has over 1,700 certifications.
- Ability to design and integrate cloud solutions across multiple vendors
  - Their Data Centers and Cloud Architectures provide differentiated services that make it easy for their customers.
  - ePlus is uniquely poised to help their customers adopt a multi-cloud strategy their cloud cost management framework.
- Proven track record of acquisitions and accelerating growth.
  - Since 1997, ePlus has successfully integrated 28 acquisitions, which are integrated into the ePlus platform to accelerate growth.
- Growth and Profitability
  - They have been centered around revenue growth, having a CAGR of 6.7% on revenues, and 9.9% on gross profits, respectively. (YoY)

Furthermore, in the SEC filing they also gave investors information about their growth strategy, this strategy consists of:

Be the partner of choice for their customers for IT, lifestyle, consulting, management, and professional solutions.
- Strive to provide excellent customer service, pricing, availability, and services.
- They plan to stay ahead of the rapidly changing IT trends through their experienced and advanced solutions.
  - An example of this is their focus on dominating the cloud space.
- Deliver the best possible product to their customers, to get referral sales via word of mouth.
- Differentiate themselves by providing the most advanced products to their customers.
- Leveraging their existing partnerships (ie. Amazon AWS, Cisco etc.) to drive sales.
Build their Geographic footprint
- Actively seeking to acquire new relationships to broaden their customer base and expand their geographic reach.
- Furthermore, the more data that ePlus can collect in different geographies and companies, the better their services will be able to perform.
Recruit, retain, and develop employees
- Hire purposefully and enhance their technical and skill bases.
- Use ePlus’ expertise to help develop their new hires into top-level talent.
Improve operational efficiencies
- ePlus is continuously investing in internal technologies, infrastructure, and software to optimize and streamline their operations to reduce costs.

Valuation information:

WACC:

I found this figure on a website called tracktak, which provides information about companies when conducting a DCF model.

CAGR (DCF #1):

I found this CAGR of 9.9% through ePlus’ SEC filings, in which they reported that their gross profit increase by 9.9% YoY.

CAGR (DCF #2):

I found this CAGR of 21.87% through ePlus’ SEC filings, in which their adjusted EBITDA growth rate over the past 5 years equalled 21.87%.

Interest Expense Growth Rate:

In order to arrive at the interest expense growth rate, I found the CAGR of their interest expense between 2016-2020, which cam out to be 9.69%.

Tax Rate:

In their SEC filings, they reported that their effective tax rate for 2020 was 28%.

Investment Valuation and Plan:

Valuation:

In order to properly value ePlus I underwent 3 comparable analyses, as well as 2 DCF models.

DCF #1:

In this DCF I used the 9.9% CAGR, as well as the other information found in the “Valuation information” section of this report. This DCF model was the more pessimistic outlook, and implied a share price decrease of 31.96%., this would translate into a share price of $63.06 (current price is $92.68). However, since I found 2 different CAGR’s I decided to undergo another DCF to compare the results.

DCF #2:

In this DCF I used the 21.87% CAGR, as well as the other information found in the “valuation information” section of this report. This DCF model was the more optimistic of the 2 models and implied a share price increase of 15.94%, which would translate into a share price of $107.45 (current price $92.68). The results achieved in this DCF model are drastically different from the past DCF model, so I decided to average the results to get a relatively unbiased valuation.

DCF – Average:

As previously mentioned, I decided to take the average price of the 2 DCF models conducted. By doing this I got an average valuation of $90.06 per share, which implies a downside of 2.82%. In order to get information to prove or disprove this valuation I decided to undergo 3 different comparable analyses.

Comparable Analyses:

EV/EBITDA:

This multiple is commonly used in investment analysis and is standard practice if the information is available. By comparing their EV/EBITDA multiple to ePlus’ competitors, (listed above in the “competitors” section of this report) the estimated fair value of $PLUS is $104.81 which implies an upside of 13.09%. This is quite reasonable and is relatively close to the results achieved in the DCF model even though one of them implied $PLUS is overvalued and the other implies that it is undervalued.

EV/Revenue:

This multiple is often used in acquisitions, which we know ePlus has plenty of past experience with through the completion of 28 acquisitions. By comparing ePlus’ EV/Revenue multiple to their competitors I arrived at a fair value per share of $391.23, which implies an upside of 322.13%. This is absurdly high, and thus I decided to void this result from the average comps price estimate.

P/E:

P/E is another very common multiple, and I decided to observe this multiple to get a better idea of a proper valuation of $PLUS through comparable companies. I arrived at a fair price per share of $115.84, or an upside of 24.99% using this comparable. This result was both reasonable and consistent with the result achieved in the EV/EBITDA comparable.

Comps – Average:

In order to put one all encompassing price estimate by looking at comparable companies I decided to take the average of the EV/EBITDA, and P/E multiples. As you may have noticed I decided to factor out the EV/Revenue multiple because the result was an outlier. By doing this I achieved an average price target of $110.32.

Plan:

In order to get the most out of this investment, you would need to enter a position between $90-93. Anything higher than this limits upside and make thee investment significantly riskier, and anything below this price point would be a strong buy.

I would look to exit my position somewhere in the middle of both the valuations, this would be between $101-104. This price is constant with many analysts who have a median price target of $102/share. Selling at between these levels (given an entry at current price ($92.68)) would yield an upside of 8.98-12.21%.

Catalysts:

News about ePlus helping to fix supply chain problems of their customers.
- If they can prove that their software works and is effective it is likely to see more partnerships and contracts for their services.
If ePlus announced that they are using blockchain technology to help take their supply chain software to the next level.
- There are many useful applications for blockchain technologies in supply chains, which is why companies that use blockchain in their supply chain are set to grow at a CAGR of over 80%.
  - ePlus can adopt blockchain technology to take advantage of the high sector growth rate.
  - ePlus has not hinted at this yet, so it is unlikely but still very possible.
- If they can meet or exceed their growth plans.
  - Doing this will help ePlus to maximize their growth, which will be reflected as increased revenue and EBIT on their earnings report.
- News about ePlus expanding into new geographies
  - If ePlus expands their geographic reach they will also be expanding their customer base and should increase their revenues.
- Any new acquisitions
  - ePlus has a history of acquisitions, and it is likely that they will continue acquiring companies in the future, this could serve as a catalyst as long as they are not overpaying.
- Future stock buybacks
  - If they continue to buy back shares at the rate, they did in 2019, then these buybacks will send a bullish signal to investors and help to lift the share price.

Risks:

The stock is already close to fair value.
- According to the DCF model and average DCF valuation, ePlus could already be overvalued.
  - There is some downside risk and not tremendous upside potential, so this is a riskier investment.
- Losing a large volume customer
  - In their SEC filing they said that losing such a customer could have adverse effects on their financial reports, and that their contracts with these customers are terminatable with 30 days notice (not very secure).
- Rising interest rates.
  - ePlus offers fix-rate borrowing which locks in a certain interest spread, and if interest rates suddenly rise, their spread will decrease, and they will be less profitable.

Portfolio Reasoning:

Fits in with the philosophy of my portfolio.
- Small Cap stock
- Undervalued (although only slightly)
- Has a good macroeconomic outlook
Helps to diversify my portfolio
- I am yet to add a tech/software stock into this portfolio as it is hard to find undervalued software stocks.
- This investment is a little riskier than my previous positions, however by diversifying it helps to reduce the overall risk of the portfolio.
Does not have high beta
- When building a portfolio, many people try to keep their beta below 1.
  - This stock has a beta of 1.34 (which means it is 34% more volatile than the market (S&P 500)
  - Many software companies have higher beta’s (average is around 3)