I find the software business endlessly fascinating. A truly unique and useful piece of software could be the cornerstone for a great business. Developing and defending intellectual property like this may be expensive upfront, but it promises high margins, recurring revenue, competitive advantages, and low distribution costs on a long-term basis. In recent years, providing software as a service (SaaS) has made the model even more lucrative. Canada’s largest industrial SaaS providers — Kinaxis (TSX:KXS) and Descartes (TSX:DSG)(NASDAQ:DSGX) — are at the pinnacle of Canada’s technology sector. Both are…
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I find the software business endlessly fascinating. A truly unique and useful piece of software could be the cornerstone for a great business. Developing and defending intellectual property like this may be expensive upfront, but it promises high margins, recurring revenue, competitive advantages, and low distribution costs on a long-term basis.
In recent years, providing software as a service (SaaS) has made the model even more lucrative. Canada’s largest industrial SaaS providers — Kinaxis (TSX:KXS) and Descartes (TSX:DSG)(NASDAQ:DSGX) — are at the pinnacle of Canada’s technology sector.
Both are focused on different parts of the global supply chain and have different clientele and unique value propositions, but for investors looking at exposure to enterprise technology, they’re highly comparable.
Here’s a look at how these two investments compare:
On the surface, the business models of both Kinaxis and Descartes seem similar. Both companies focus on pulling in corporate clients for long-term contracts to use their respective software suites and invest heavily in creating innovative solutions for the logistics industry.
However, I spoke with the manager of Kinaxis’s investor relations team, Rick Wadsworth, who explained that the target market and products of the two companies were completely different and somewhat complementary.
While Kinaxis provides global supply chain management solutions focused on the flow of inventory on shipping containers and international ports, Descartes provides a last-mile delivery solution for logistics companies. In other words, Kinaxis’s prospects are more aligned with international trade while Descartes’s prospects rely on the e-commerce and manufacturing sectors.
This differentiation means a tech-focused investor can add both stocks without compromising portfolio diversification. However, it also means both companies have different growth prospects.
Despite the ongoing U.S.-China trade war, international trade continues to grow. According to the World Trade Organization, global merchandise trade volume grew 4.4% in 2018. Steady growth like this could flow to Kinaxis’s bottom line over the long term.
However, e-commerce is expanding much more rapidly. E-commerce sales grew 15% in the U.S. last year and could be up nearly 50% by 2023 across North America. In less-developed parts of the world, e-commerce is growing even more rapidly. All these online purchases will have knock-on effects on freight and package delivery services, which will impact Descartes’s bottom line.
By this macro measure, Descartes seems like it could grow faster than Kinaxis, but acquisitions (both of smaller companies and larger customers) could define actual growth for both players.
Finally, a quick comparison of the fundamentals is in order. Kinaxis trades at a forward price-to-earnings (P/E) ratio of 65, while Descartes trades at a forward P/E ratio of 56.
Descartes has a lower ratio, despite the fact that its earnings have been growing and are expected to keep growing faster than Kinaxis’s. Based on this direct comparison, Descartes seems like a better buy for investors.
Canada’s leading SaaS providers have similar business models, customer retention, and acquisition-driven growth strategies, but their products and end-market are differentiated.
This means Descartes has better growth prospects than Kinaxis, and trades at a cheaper valuation. Investors looking for a steady tech investment should favour Descartes, in my opinion.
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Fool contributor Vishesh Raisinghani has no position in any stocks mentioned. Kinaxis is a recommendation of Stock Advisor Canada.