Energy Security And Complex Reservoirs Will Power This Subsurface Software Leader

Catalysts

About Computer Modelling Group

Computer Modelling Group develops physics based reservoir simulation and related subsurface software that energy companies use to plan and manage complex upstream and CO2 storage projects.

What are the underlying business or industry changes driving this perspective?

• Greater focus by operators on maximizing recovery factors, including aggressive targets around 50% recovery, is pushing more projects toward complex enhanced oil recovery workflows. CMG’s physics based simulation tools are deeply embedded in these workflows, which can support higher license utilization and recurring revenue.
• Rising investment in energy security by national and international oil companies is leading to renewed upstream spending in regions such as Asia, Latin America and the Middle East. This is creating a larger pool of projects that can use CMG’s software suite, with potential to lift revenue and earnings over time.
• Growing importance of complex reservoirs, heavy oil and mature fields in countries such as Venezuela, Mexico, Algeria, Angola, Nigeria and Libya aligns directly with CMG’s long standing technical strengths. This can support new customer wins and broader deployments that benefit recurring revenue and free cash flow.
• Industry interest in combining high fidelity seismic interpretation with advanced reservoir simulation is playing to CMG’s expanded portfolio after four acquisitions. Joint proposals across its companies are creating opportunities for multi product deals that can increase average contract value and support net margins.
• Customer demand for best of breed point solutions rather than single vendor suites is supporting CMG’s positioning as a specialist technology provider across the upstream workflow. This can help maintain pricing power, support adjusted EBITDA margins and contribute to more resilient earnings.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more optimistic perspective on Computer Modelling Group compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming Computer Modelling Group's revenue will grow by 6.6% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 12.4% today to 21.9% in 3 years time.
• The bullish analysts expect earnings to reach CA$32.9 million (and earnings per share of CA$0.41) by about August 2029, up from CA$15.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 15.1x on those 2029 earnings, down from 20.1x today. This future PE is lower than the current PE for the CA Software industry at 38.3x.
• The bullish analysts expect the number of shares outstanding to decline by 5.54% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.0%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Computer Modelling Group is relying heavily on acquisitions to build a second growth engine, while organic recurring revenue has recently been weak and declined 12% this quarter, which could limit long term revenue growth and pressure earnings if acquired revenue cannot consistently offset softer demand in the core business.
• The company is deliberately winding down noncore professional services at Bluware and expects professional services revenue to fall by $6 million to $7 million this year, which structurally reduces a revenue stream that previously supported total revenue and adjusted EBITDA margins.
• Management plans to draw up to $20 million on the credit facility to fund a substantial issuer bid at the same time as it pursues further acquisitions, which increases financial risk and could constrain future flexibility if free cash flow or adjusted EBITDA are weaker than expected.
• Customer budgets in North America remain cost conscious despite interest in energy security, and some international markets that Computer Modelling Group is targeting for new logos have been disrupted by conflict, which could slow adoption of its software and weigh on recurring revenue and free cash flow over a multi year period.
• Computer Modelling Group’s approach to AI is to augment rather than replace physics based simulation, yet the broader software market is moving quickly, and if alternative subsurface tools achieve acceptable accuracy with lower cost or faster deployment, this could erode pricing power and reduce future net margins and earnings growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for Computer Modelling Group is CA$6.0, which represents up to two standard deviations above the consensus price target of CA$5.2. This valuation is based on what can be assumed as the expectations of Computer Modelling Group's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$6.0, and the most bearish reporting a price target of just CA$4.5.
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2029, revenues will be CA$150.6 million, earnings will come to CA$32.9 million, and it would be trading on a PE ratio of 15.1x, assuming you use a discount rate of 8.0%.
• Given the current share price of CA$3.98, the analyst price target of CA$6.0 is 33.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.