Cloud And Connectivity Trends Will Support Stable Long Term Earnings Profile

Catalysts

About ScanSource

ScanSource distributes specialty technologies and recurring IT and communications solutions to channel partners globally.

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

• Growing demand for cloud compute, connectivity and CX solutions, together with ScanSource's focus on helping partners sell more cloud recurring revenue, supports the mix shift toward higher recurring revenue and can influence gross profit stability and earnings resilience.
• The acquisition of MicroAge brings capabilities in cloud, cybersecurity, data center and AI services such as cloud migration, cybersecurity support and AI data center implementation. These capabilities can widen ScanSource's total addressable market and affect future revenue growth and margin mix.
• The long running move from on premises communications to cloud based, everything connected architectures is aligning with ScanSource's converged communications approach. This approach is designed to help partners attach more edge devices and services and can impact product net sales and recurring revenue contribution.
• Stronger demand for physical security, mobility and networking hardware in North America, together with the return of large deals, is supporting the Specialty Technology Solutions segment and can affect segment net sales, gross profit and adjusted EBITDA margins.
• Rising connectivity needs from data center links back to enterprises are supporting Intelisys opportunities in connectivity and cloud services. These opportunities can influence recurring revenue levels, segment adjusted EBITDA and the overall share of gross profit from recurring streams.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming ScanSource's revenue will grow by 7.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 2.4% today to 2.7% in 3 years time.
• Analysts expect earnings to reach $111.0 million (and earnings per share of $5.27) by about September 2029, up from $78.9 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 11.5x on those 2029 earnings, down from 14.5x today. This future PE is lower than the current PE for the US Electronic industry at 28.9x.
• Analysts expect the number of shares outstanding to decline by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.09%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• ScanSource is seeing stronger demand across key technologies such as physical security, mobility, networking, CX, cloud compute and connectivity, and management describes the business as being at the beginning of a stronger growth trajectory. This could support higher revenue and earnings than implied by an assumption that the share price remains flat and may put upward pressure on the valuation multiples.
• The planned acquisition of MicroAge expands ScanSource's exposure to areas like cloud, cybersecurity, data center and AI services and is described as accretive with positive free cash generation. Successful integration and growth of this business could lift revenue, gross profit mix and free cash flow, which could support a higher share price over time.
• Management is placing more emphasis on winning new business and taking market share, including changes in leadership and sales structure and renewed focus in Intelisys on higher growth technologies such as cloud compute, connectivity and CX. If this approach leads to sustained share gains it could support faster revenue growth and higher adjusted EBITDA than implied in a flat share price view.
• Intelisys is seeing improving trends in connectivity driven by higher bandwidth needs from data center connections back to enterprises. If this long term demand for connectivity and related services continues it could increase recurring revenues and segment adjusted EBITDA, which can support a higher overall earnings base for ScanSource.
• ScanSource has low net debt leverage, significant free cash flow of US$114 million and ongoing share repurchases with US$121 million remaining under authorization. If this capital deployment reduces the share count further while earnings grow it could support higher earnings per share and potentially a higher share price than expected.

Valuation

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

• The analysts have a consensus price target of $60.5 for ScanSource based on their expectations of its future earnings growth, profit margins and other risk factors.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $78.0, and the most bearish reporting a price target of just $43.0.
• In order for you to agree with the analysts, you'd need to believe that by 2029, revenues will be $4.0 billion, earnings will come to $111.0 million, and it would be trading on a PE ratio of 11.5x, assuming you use a discount rate of 9.1%.
• Given the current share price of $56.96, the analyst price target of $60.5 is 5.9% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• 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.