BMO’s 3 Canadian small cap tech picks

Ruth Saldanha: Technology has been one of the strongest-performing sector so far this year with two U.S. technology stocks, Apple (APPL) and Amazon (AMZN), crossing the US$1 trillion valuation mark. Is there more juice left in the sector? For Canadian tech stocks in particular, what's the outlook and is there more potential upside? With me to discuss this we have Tyler Hewlett, Director, Portfolio Manager and Head of Canadian Growth Equities at BMO Asset Management

Tyler, thanks so much for joining us.

Tyler Hewlett : Thank you.

Saldanha : To start with, there has been a strong price appreciation in tech so far this year. Do you think there's more juice left in this sector? What's your outlook for this sector, especially for Canadian technology?

Hewlett: So, the performance in the technology sector has obviously created quite a bit of buzz in the media and on the minds of investors due to the strong price appreciation over the last couple of years. What often gets lost in this talk about whether is more to go in this sector or how expensive the sector is, is how great the fundamentals are in the tech sector, particularly in the software space. So, when we look at the software space, what we see are companies that can grow at very, very high rates for long periods of time and that have very strong cash flow and earnings fundamentals as well. So, from our perspective, as long as the earnings and the cash flow of these companies stay strong, we think this is a trend that could keep going for a very long time and some of the high multiples that you are seeing in the stocks are just reflecting the fantastic business models of a lot of these companies.

Saldanha : How does this play into the Canadian tech market? Is it the same there?

Hewlett: Right. So, tech is a much smaller sector in Canada than it is in the U.S. And you do have very, very strong companies that have been very strong performers over long periods of time but the composition of them is a bit different. So, two larger names, for examples, in Canada, CGI Group (GIB.A) and Constellation Software (CSU), great companies that have grown their earnings very well, but the overall revenue growth of these companies is much lower than some of the stocks that you see in the U.S. and the companies are more mature than some of the growth trajectories you see from a lot of U.S. tech stocks.

Saldanha : One of the funds that you manage is the BMO Canadian Small Cap Equity Stock which does have a lot of small-cap tech stocks in the portfolio. Can you run us through what the strategy is for that particular fund?

Hewlett: Sure. So, the BMO Canadian Small Cap Equity Fund is a fund focused on Canadian small and mid-cap stocks. We take a very long-term approach from our investment perspective. We think taking a long-term approach is one of the only advantages left to fundamental investors. What we are looking for are stocks that we believe can appreciate in value over time through companies creating value. So, what we are looking for here, it is a growth-oriented fund. So, we are looking for companies that we think can grow for very long periods of time profitably and on a per share basis. So, when you think of those characteristics, those are characteristics that a lot of tech stocks have as well. So, tech has always been a sector that we have been overweight in the fund.

Saldanha : In this fund one of the stocks that you really is Kinaxis (KXS). Can you tell us what you like about that particular stock?

Hewlett: Sure. So, Kinaxis is a stock that we've owned since the company IPO-ed a few years ago. So, Kinaxis is a software-as-a-service company in the global supply chain industry. So, they help companies with very complex supply chain. So, think about companies like Ford and Toyota and Honeywell. And they help these companies deal with very complex supply chain. So, for example, something goes wrong in the company's supply chain, which often happens because of the complexity, Kinaxis will help them figure out the best way to fix the issue and reallocate resources to get customers and suppliers their products as quickly as possible.

Saldanha : Another company that you really like but that has 90% of its business outside Canada is Descartes Systems Group (DSG), is that right? Why do you like that company?

Hewlett: Yeah. So, Descartes is actually a company we've held in the fund for over 10 years now. So, again, talking about taking a long-term approach. This is our goal. Buying companies that we can hold for many, many years. Descartes is also in the software business, more on the logistics and transportation industry. So, they help companies deal with things like cross-border transactions, shipping of goods, customs. They also have software solutions in the home delivery business. So, with the proliferation of ecommerce, that has been a real benefit to Descartes. They help companies get their products to end consumers through routing deliveries in the most efficient way possible. So, Descartes has been a growth story over the years through a combination of both organic and acquisitive means. The company has very, very strong cash flow. They have been able to grow their earnings by over 15%, again, for over a decade now and we really see this as a company that can continue to grow and get much bigger over time.

Saldanha : The third company that you like is Solium (SUM), which is actually much smaller than the other two. What do you like about that particular stock?

Hewlett: So, Solium is a company serving the employee equity plan market. So, think about things like employee stock purchase plans. And Solium is smaller and earlier stage. Despite running a profitable business for many years, the profitability hasn't been as high as you see in companies like Kinaxis and Descartes which have been able to grow and scale their business. We think that's something that's changing. Over the last couple of years, Solium has announced two large global financial services companies as big customers that will be rolling out their software to their own customers. So, we really see that Solium is about to enter an inflection point. One, we think their revenue can really grow from here by adding two very large customers. It also highlights and validates their business and we think that the company should be able to add other large companies over the years going forward to help grow their business and scale to reach profitability that companies Kinaxis and Descartes have reached.

Saldanha : Thank you so much for joining us today, Tayler.

Hewlett: Thank you.

Saldanha : For Morningstar.ca, I'm Ruth Saldanha.