CGY (TSX) - Calian Group Ltd.

Calian Group Limited (TSX:CGY) is a diversified industrial consulting company. The company provides diverse services and products through four segments: Advanced Technologies, Health, Learning and Information Technology. Calian’s core customer base are the various departments under the Canadian government, outside of which its customers also include both industry and government clients in the areas of aerospace, agriculture, defence, engineering, health, IT and security.

INVESTMENT THESIS

1)    Strong track record of profitable growth, which is expected to continue

Calian recently reported strong Q2/21 results, marking 78th consecutive profitable quarter and strong return on invested capital. We believe that strong historic financial performance is a function of: 1) Calian’s solid competitive position with existing clients, which results in strong client retention and win rate; 2) nature of Calian’s contracts, most of which are long-term with variable cost plus pricing; 3) the company’s focus on financial discipline, which has led to strong margin expansions.

We expect this strong track record of profitable growth to continue given: 1) our expectation that Calian will maintain its competitive position with key clients, supported by significant (and increasing) backlog over the next 10 years; 2) increase in both government spending and private sector outsourcing within Calian’s key verticals; 3) management’s continued focus on long-term profitability.

2)    Shifting mix away from Canadian government to private

One of Calian’s key strategic focus has been to diversify its revenue mix towards private-sector clients. We believe the company can achieve this by leveraging its strong existing relationship with the Canadian government clients to expand into adjacent services with private-sector clients. 2020 was a marquee year in that regard, as Calian grew its non-government revenue by 90%, shifting its revenue mix from 69% government in 2019 to 53% in 2020. In addition to leading to margin expansion, we believe this initiative can drive further revenue growth via synergies with its existing government customers and contracts and provide another revenue of growth runway.

3)    Prudent capital allocator

Calian has a clear playbook when it comes to M&A. The company accesses attractive funding sources, acquires companies that are both accretive and make strategic sense, allocate appropriate resources to integration and re-emerge as stronger company. The company’s recent acquisition of Dapasoft is a clear example of this strategy at play, given that the acquisition was on-strategy (adding proprietary service to Calian’s existing IT business, with potential for synergies across to the Health segment) and accretive to EBITDA. The company has noted strong pipeline for deals, providing upside to our forecast.

FORECAST, VALUATION AND TARGET PRICE

Our F2020 revenue and adjusted EBITDA forecasts are within management’s guidance range. Our F2021 revenue estimate of $530 MM implies growth of 6% and remains on the conservative side, given the strong backlog, strong organic growth outlook and potential for inorganic growth. Meanwhile, we expect margin expansion to drive stronger adjusted EBITDA of $52 MM implying growth of 15%, driven by shift to higher margin sales mix and other initiatives.

CGY is currently trading at 11.0x forward EV / EBITDA, which is above the company’s historical average of 9.0x and at a premium to its peer group. We derive our target price of $65.00 based on 11.0x our F2021 adjusted EBITDA forecast. Given the strong one-year return to target of 14%, we are initiating coverage on CGY with a Buy recommendation.