"In its most basic form, we would call our new holding, CDW, a participant in and enabler of many of the fastest-growing areas of technology, but with a uniquely profitable and sustainable business model at an attractive valuation. CDW was originally incorporated in 1984 as MPK Computing. The Company later became Computer Discount Warehouse and then simply CDW."
What is that "uniquely profitable and sustainable business model," and what does it offer to investors? The answer begins with the brief history Rolfe provided. Some of us will remember a time when the Computer Discount Warehouse was one of the main places for consumers to buy hardware and software, as personal computing became commonplace. Over time, that approach has changed. Today, it is an intermediary between IT departments and many technology vendors. The below graphic illustrates its business model in the 2019 annual report:
CDW sees itself as an extension to customers' IT staff, while its partners, the vendors, get access to its 250,000 customers. Its customers are businesses or governments, and the company reports across three customer segments: Corporate (250 or more employees), Small Business (fewer than 250 employees) and Public (government agencies, education and healthcare).
The company explains its value proposition as follows in its 10-K regulatory filing:
"We are positioned in the middle of the IT ecosystem where we procure products from OEMs, software publishers, cloud providers and wholesale distributors and provide added value to our customers by helping them navigate through complex options and implement the best solution for their business. In this role, we believe we provide unique value to both our vendor partners and our customers."
To implement this proposition, CDW hired many engineers and specialists for its sales teams who can provide solutions to customers as well as make sales. Rolfe noted, "This has allowed them to tap into booming areas of tech such as helping smaller organizations plan their cloud and digital workplace transitions."
This approach provides CDW with a consulting function besides its product distribution role. Rolfe compares it with Cognizant (NASDAQ:CTSH) and Accenture (NYSE:ACN).
Notably, the company does not do any manufacturing, which spares it the high capital costs incurred by many high-tech hardware companies. Instead, it represents many manufacturers, including Apple (NASDAQ:AAPL), Cisco (NASDAQ:CSCO) and Microsoft (NASDAQ:MSFT). Its biggest suppliers are Ingram Micro (NYSE:IM), SYNNEX (NYSE:SNX) and Tech Data (NASDAQ:TECD).
CDW makes it onto GuruFocus' Buffett-Munger Screener, which requires that it meet the four criteria:
- A high predictability rank, i.e. the ability to grow revenue and earnings consistently.
- Competitive advantage(s) or a moat to maintain or grow profit margins.
- Little or no debt.
- Fairly valued or undervalued based on the PEPG indicator. PEPG is the price-earnings ratio divided by the average growth rate of Ebitda over the past five years. It is also known as PEG.
The GuruFocus system gives CDW a 4 out of 5 star predictability rating, which is very good. Research shows a 4-star predictability stock should generate above-average returns and have a low risk of losing money on it if held for at least 10 years.
Predictability is based on revenue and earnings per share growth, which have been solid for the 10 years ending Dec. 31, 2019:
The company identifies the following opportunities to drive revenue growth:
- Organic growth from new customers and vendors, as well as more sales to existing customers
- Trends - "Many of the changes happening today, such as remote work, growth in digital commerce channels and business continuity redundancies, will persist and continue to scale and mature"
- Consolidation - In its investor presentation for the recent quarter, the company made a point of noting that the market is fragmented and that it, along with its two largest peers, represents only 10% of the addressable market.
For a quantitative assessment, the Macpherson model stipulates that a company has a moat if it shows a median return on capital (ROC) and return on tangible equity (ROTE) of at least a 15% over the past 10 years.
- ROC: Over the past 10 years, this metric has risen from 5.34% to 18.71%, with slow but steady improvements. It will not meet the 15% median test, but based on the progression over the past 10 years, I would give it a pass.
- ROTE: CDW has had negative tangible equity for the past decade, due in part to more than $2 billion dollars' worth of goodwill on its book since at least 2009.
At the end of 2019, the company had almost $3.3 billion worth of long-term debt. At the same time, it had $154 million of cash and cash equivalents (no marketable securities). That relationship between debt and ready cash affects CDW's financial strength rating:
As you see at the top of the table above, it has a low cash-debt ratio but reasonable interest coverage, as well as a strong Piotroski F-Score and Altman Z-Score, which shows there is little danger of bankruptcy.
PEPG or PEG score
CDW's PEG Ratio at the close of trading on June 8 was 1.78, well above the undervalued or fair-valued mark of 1.0. A score below 1.0 means undervalued and a score at or slightly above is considered fair-valued. Overvaluation is confirmed by the discounted cash flow (DCF) calculator.
What the company has in common with at least several other Buffett-Munger Screener stocks is that the price currently is below its recent highs. In other words, it's expensive but about as cheap as it's going to be for the immediate future.
Dividends and buybacks
There's another aspect of CDW that should be noted: its generous dividend and buyback policies. The forward dividend yield is 1.2% and it has had a three-year dividend growth rate of 37.9%. Over the past three years, it has also been buying back shares at a rate of 3.6% per year.
It paid a dividend of $0.38 ($1.52 annually) on May 21. There is no word on dividends and buybacks from now on as the company waits to see what happens after Covid-19.
CDW is a company with a robust business model and a history that supports its inclusion on the Buffett-Munger Screener list.
Its predictability for revenue and earnings per share growth is strong, and it has a strategy to maintain that growth. It has a moat, though not a very wide one, and that's not surprising considering that it is up against big players including Cognizant and Accenture. It has a manageable amount of debt, and although it is expensive, it is available at a price below its recent highs.
For some investors, this could be an attractive combination. However, for other value investors, the significant debt and lack of a margin of safety will land this in the "not now" pile.
Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.
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This article first appeared on GuruFocus.