CDW Corporation: Two Big Growth Catalysts Ahead (NASDAQ:CDW)

Investment Overview

I am CDW Corp.Nasdaq:C.D.W.Despite the near-term weakness, CDW has a buy rating as it sees two strong catalysts emerging that will accelerate growth beyond FY24. Specifically, the near-term catalysts are: The second half of 2024 will be a PC refresh cycle, and in the medium term, demand for AI PCs and AI-related implementations will support growth.

Overview of the project

CDW sells IT products and services to businesses of all sizes. Fact SheetCDW offers over 100,000 products across over 1,000 brands, including both hardware and software products. In terms of segments, revenue is split across three major segments: Commercial, which CDW sells to businesses, is the largest revenue contributor (52% of revenue), Public, which includes government and healthcare customers, is the second largest revenue contributor (35% of revenue), and others account for 13%.

Very challenging macro environment in the near term

We expect the challenging macro environment will continue to put pressure on CDW’s near-term performance. This trend was well illustrated in the company’s Q1 2024 results, where revenue declined across all segments and total revenue fell 4.5%, marking the sixth consecutive quarter of declines. This also marks the third consecutive quarter that CDW has missed consensus expectations, indicating that conditions remain much worse than the market expected. We expect the pressures of the current macro environment to continue, resulting in longer sales cycles and project deferrals as clients prioritize cost-saving initiatives and initiatives with faster payback periods (Return on InvestmentManagement’s guidance also clearly reflects these macro headwinds, lowering its fiscal 2024 EPS growth rate to low single digits from its previous guidance of mid-single digit growth.

However, on the bright side, CDW is not seeing any project cancellations, just more budget scrutiny and project postponements, which in my opinion will translate into pent-up demand. This is good news for CDW because once they exit this downward cycle, the company’s growth could spike. The question is when the cycle will turn, but I believe there are two big catalysts that will drive this recovery:

Two powerful catalysts lie ahead

The first catalyst is the PC refresh cycle, Occurs in late 2024The impact for CDW is that each additional PC (business workstation) creates multiple sales opportunities for CDW, as users are more likely to need specific computer peripherals (mouse, cables, keyboard, etc.) and software (business applications, cyber security, etc.) In fact, signs of this are already emerging as CDW saw higher than expected PC demand across all end markets in Q1 driven by refreshes of older devices and Windows 11 upgrades.

Additionally, there is another fundamental catalyst in this refresh cycle that will further drive the growth of this cycle: the increasing availability of AI PCs. In my view, it is only a matter of time before AI PCs become the majority (IDC estimates it at 60% It is expected to account for 10% of global PC shipments by 2027. Especially for business use cases, as companies look to leverage AI in all aspects of their business to improve productivity and efficiency. The current constraint is availability. Microsoft has announced the first batch of Copilot Plus AI PCs. Several days Increased availability could boost demand for AI PCs, which are more expensive than traditional PCs (a price tailwind for CDW).

Looking ahead, we expect PC refresh momentum to continue beyond 2Q2024, with demand for AI PCs supporting the medium-term growth outlook.

The second catalyst is also AI-related. I believe the world is still in the early stages of generative AI opportunities. This means that customers are still in the experimentation phase, testing whether Gen AI will actually meet their use cases. The risks of dealing with Gen AI will also be a barrier for companies to invest in this emerging technology, especially due to data security risks.80% of companies They say data security is their biggest concern, and with macro uncertainty on top of that, it’s unlikely this pent-up demand will translate into revenue anytime soon.

However, I believe these issues, like previous emerging technologies, will eventually be resolved. Eventually adopted (The Internet is a good example.) And the pace is fast. In fact, I believe that general-purpose AI can greatly improve enterprise productivity and that every business owner will find a way to take advantage of it. Recent CIO Technology Survey A survey conducted by Foundry noted that while budgets are still tight, AI is the primary focus, so given CDW’s broad portfolio of products and solutions (a search for “AI” on CDW’s website brings up over 500 results related to services, software, services, storage, and more), we expect generative AI to eventually become a growth tailwind as customers move from evaluation to implementation.

The tricky part is figuring out exactly when to make the shift, and while we’re confident that this won’t drive CDW’s growth in the coming quarters, we do see this becoming a big growth driver in the medium term.

evaluation

In the near term, I believe the challenging macro environment will continue to put pressure on CDW’s growth, meaning that FY24 will likely be another negative year. However, growth should turn positive in FY25/26, supported by a recovering macro environment (inflation is currently moving in the right direction) as the PC refresh cycle begins in the second half of 2024 and AI PCs become more prevalent. Beyond FY25/26, growth should continue to be supported by companies preparing to deploy AI-related solutions and hardware. Looking at CDW’s revenue growth historically, it has never seen growth decline for more than two consecutive years, which I believe is consistent with the timeline in which I expect growth to recover in FY25.

CDW’s outlook going forward is -5% growth in FY24, 5% YoY growth in FY25, and 10% YoY growth in FY26. The rationale for this outlook is that while macro conditions are clearly adverse in FY24, the timeline for PC refresh in the second half of FY24 should mitigate some of this headwind. As such, growth in FY24 should be less significant than FY23. Growth in FY25 is expected to recover gradually as some of the macro headwinds may spill over. FY26 should see a full recovery in growth to around the 10% range we’ve seen thus far.

For earnings guidance, we used management’s targeted adjusted earnings since the market values ​​CDW based on adjusted earnings (CDW stock price at time of writing is $231.57 with forward adjusted (normalized) EPS forecast of $10.12, equating to ~23x). Conservatively, we expect revenue growth to be negative, so we assumed flat margins in FY24 (although net margins improved in FY23 despite -10% growth). In FY25 and FY26, we expect net margins to grow at 40 bps per year, the same pace as the past decade.

The market currently values ​​CDW at a forward PE of 21x (CDW’s standard deviation over its 5-year trading range +1) because I believe a recovery is expected in FY25. In my model, I assume CDW will trade at a forward PE of 20x, the average over the past 5 years, because I do not expect growth to accelerate further beyond 10%. Applying this multiple implies a market cap of approximately $33.3B.

We’ve also included capital return in calculating total return, because over the past few years CDW has returned capital to shareholders through share repurchases and dividends. Using the same share repurchase rate (2% per year) and the consensus expected DPS yield, we expect total return to be about 19% (17.6% share price appreciation and about 1.7% dividend appreciation).

danger

The big risk is the timing of the growth recovery. The current macroeconomic headwinds could persist for a longer period, putting further pressure on businesses’ willingness to increase their technology spending budgets. The larger implication is that PC refresh cycle timelines are likely to be delayed as businesses seek to further deplete their current assets.

Another thing that concerns me is the amount of debt remaining on CDW’s balance sheet: As of Q1 2024, the company has approximately $4.8 billion in net debt. In a worst-case scenario, if CDW were to experience a repeat of the decline it experienced in FY2009 (EBITDA down 22%) (which could be for a variety of reasons, including a global recession in the event of a full-scale conflict in the Middle East), CDW could be forced to cut back on share buybacks and dividends as its leverage ratio rises.

Conclusion

Overall, despite near-term headwinds from the macro environment, I am recommending CDW as a buy due to two key factors: first, the expected PC refresh cycle in 2H 2024, and second, the demand for generative AI. While the exact timing of this inflection point is unknown, I believe CDW’s broad product portfolio puts it in a good position to take advantage of these two factors. The main risks to this thesis are the possibility of a prolonged economic downturn that slows the PC refresh cycle and CDW’s debt levels.