Wayside Technology Group, Inc. (NASDAQ: WSTG) is an information technology company that resells hardware and software solutions to customers in the U.S. and Canada. Since it was founded in 1982, the company has grown to specialize in virtualization, networking, software development, database modeling, security and other technical domains, with products from vendors ranging from VMware, Inc. (NYSE: VMW) to Intel Corporation (NASDAQ: INTC).
Of course, there's an obvious problem with this business model: Middlemen tend to see their margins squeezed over time. The company's gross margins seem to have confirmed this sentiment over the past several years, falling from about 11% in FY 2009 to an 8% run-rate this year. But, investors looking a little bit deeper could find a company that has managed to keep its net margins and cash flow steady enough to pay a health 5% dividend to investors.
Relatively Stable Margins
Wayside Technology Group may have seen its gross margins drop over the past five years, but its operating income and net margins have been much more consistent (see Figure 1). By lowering its SG&A from 7.7% in FY 2009 to just 5.2% during the trailing 12-month period, management has boosted its bottom line. The evidence for these bullish trends is earnings per share, which has grown from $0.65 to $1.24 per diluted share over the same timeframe.
Figure 1 - WSTG's Margin Trends - Source: Financial Statements
Gross margins will eventually win out over operating and net margins, since SG&A cost cutting can't be extended infinitely deep. Moreover, management indicated in a Q2 2013 conference call that price competition persisted during the quarter and margins will continue to be affected by the current trend. But fortunately, the company's revenues have been rapidly growing and it has been focusing on new segments in order to improve long-term margins.
Strong Top-Line Growth
Wayside Technology Group's revenues have grown significantly over the past five years, from around $146.4 million in FY 2009 to more than $300 million in the trailing 12-month period, while its net income has grown over the same period from about $2.9 million, or $0.65 per diluted share, to more than $5.7 million, or $1.24 per diluted share (see Figure 2). These trends suggest robust growth on the top-line that has overcome margin erosion.
Figure 2 - WSTG's Financial Trends - Source: Financial Statements
In its FY 2012 10-K filing with the SEC, the company attributed its top-line growth to increased account penetration, ongoing expansion of virtual infrastructure initiatives, and the addition of several key product lines in its Lifeboat Distribution segment. And in its TechXtend segment, management reported larger extended payment term transactions, solution focused selling, and higher average order sizes as key drivers of the 39% growth in that division.
Shifting Towards Software
The big questions for investors are whether or not this top-line growth is sustainable and whether margins will stabilize in the future. Management addressed both of these concerns in its Q3 2013 conference call, where CFO Tom Flaherty indicated that management's focus was on signing new software vendors in order to drive growth. The company also signed its first software-as-a-service provider, showing that it has a strategy to capitalize on the cloud.
Dan Jamieson, VP of Lifeboat Distribution added in the call:
Our role is as a trusted advisor we see that transforming into the cloud. One other things that values we add with our vendor partnerships is that we introduced the right resellers into the mix, that will continue. We feel as a relationship driven company that the cloud represents extraordinary opportunity for us because it really matches well with our value proposition.
The trend towards software-as-a-service and virtualization suggests on the surface that the company's model may be outdated. But in reality, even software-as-a-service providers need someone to set up and train users, while the trend towards virtualization continues to create new business. Management's confidence in executing on these trends is evident from the recent dividend hike that brought its yield up to an impressive 5% annually.
Relative & Absolute Valuation
Wayside Technology Group appears to be trading at a discount to both its relative and absolute intrinsic value using a number of metrics. By Morningstar's estimates, the company trades with a price-earnings ratio of 11.2x, price-book ratio of 2.0x, and price-sales ratio of 0.2x. While its price-book and price-sales ratios may be slightly higher than some of its more direct competitors, its price-earnings ratio remains markedly lower (see Figure 3).
Wayside Technology Group Inc.
Avnet Inc. (AVT)
Ingram Micro Inc. (IM)
Figure 3 - Valuation Comparisons - Source: Morningstar.com
The company's true value story may be on an absolute basis, with a healthy 18.21% return on equity for capital appreciation investors and a 5% dividend yield for income investors. With a payout ratio of 51.5% in the trailing 12-month period and $14.2 million in the bank, the company's dividend yield also appears to be safe for the time being. And finally, $32 million in shareholders equity helps create a margin of safety for investors at these levels.
Risk Factors & Conclusions
Wayside Technology Group probably isn't the best equity for long-term capital gains, but its growing dividend yield and discounted valuation make it a potential opportunity for income investors to include into a diversified portfolio. Moreover, management's success in growing revenues in the past and confidence in future growth - as evidenced by the dividend hike - could suggest some capital gains appreciation as an added bonus.
Of course, there are several risks that investors should carefully consider:
- Micro-cap Equities - WSTG is a micro-cap stock with a market capitalization of just $63.5 million, which means that it may not be as liquid or safe as large-cap stocks.
- Long-term Outlook - WSTG operates in a difficult industry that's characterized by a high amount of competition, which could lead to further margin pressure.
- Customer Concentration - WSTG has a modest amount of customer concentration, with only a few of its major customers accounting for more than 10% of revenue.