ALIT - Alight: Weak BPaaS Guide Is Not A Big Issue Reiterate Buy

2023-08-15 04:55:32 ET

Summary

• I reiterate a buy, with expectations of continued growth and a recent dip in ALIT's share price.
• Key operating metrics like revenue and EBITDA continue to stay on the right track of expansion.
• 2Q23 results were positive, with revenue and recurring revenue exceeding expectations, and management maintaining most of its FY23 guidance.

Overview

My recommendation for Alight (ALIT) stock is a buy, as I expect the business to continue growing as guided over the mid-term. The dip in share price due to the weak BPaaS guide is a buying opportunity, in my opinion, as I view it as a near-term blip rather than a structural weakness. Note that I previously gave ALIT a buy rating as I became optimistic about the company's mid-term growth guidance.

Business

ALIT is a company that offers human capital solutions and offers a cloud-based solution that is more efficient and effective than traditional approaches. I believe ALIT is well-positioned to capture the change in the HR industry, where there is an increasing focus on temporary workers and employee wellbeing, as well as the need to navigate complex regulatory landscapes.

Recent results & updates

I view the 2Q23 results as overall positive. A 12.7% increase brought 2Q23 revenue to $806 million, which was $5 million more than the consensus estimate of $800.8 million. Along with it, recurring revenue grew by 13.6% to $683 million. EBITDA profitability also surpassed expectations, coming in at $157 million. As for guidance, management maintained most of its FY23 guidance after the strong results of the second quarter. They reiterate FY23 guidance for revenue between $3.47 and $3.51 billion, an increase of 11-12%, and also $735-$750 million for EBITDA and $0.62-$0.67 for EPS.

My take on the guidance remains that it might be too conservative. I believe there is potential for ALIT to experience a surge in earnings and profitability based on its current investment strategies. According to the call, ALIT is on track to migrate its data center-hosted applications to the cloud, which will lower the company's capital intensiveness and help it meet the ambitious mid-term margin expansion targets set by management. I think that moving data to the cloud presents opportunities for ALIT to optimize their pricing model (since it is simpler to perform analysis on data in the cloud using AI, ML, etc.) in addition to reducing capital intensity. I expect this impact to be huge, as the new pricing model has not found its way into ALIT's backlog.

We also continue to monetize our offerings through a modernized pricing model that is being rapidly accepted by customers and provides upside going-forward.

We're making progress with new logos and we've introduced our new pricing model, which is not yet contemplated in our total backlog. Our pricing model is being implemented in new deals and will enable us to monetize new products more effectively. (2Q23 earnings call)

The bad news for the quarter, however, is that the BPaaS bookings guide has been lowered from $900 million to $1 billion to $700 million to $900 million. The fluctuations in bookings are likely due to timing and the lumpiness that comes with landing big deals, but I don't think there's anything fundamental going on there. I'd like to remind shareholders that ALIT has firmly surpassed BPaaS growth targets set nearly three years ago. Investors should also be aware that BPaaS is a poor metric because it can be influenced by both timing and size, in my opinion. However, this is likely to keep putting pressure on the stock for the foreseeable future as it bad from a headline basis. I still believe that primary indicators, such as revenue growth and EBITDA margin expansion, should receive the most attention. These indicators are still very healthy, and so is my belief in the stock for the next few quarters. Therefore, I consider the current stock price drop to be a good buying opportunity.

Valuation

According to my model, ALIT is valued at $11.5 in FY24, representing a 35% increase. This target price is based on the same growth forecast I had for ALIT in my previous update, as I did not see any fundamental change to the business's growth trajectory. I reiterate my viewpoint that the weak BPaaS guide is just a matter of timing. Given performance so far into FY23, I believe ALIT can achieve its FY23 guidance and mid-term guidance of 6-8%. Given the current valuation (which has gotten cheaper since my last update), we simply need earnings to grow, as I assumed, to make attractive returns. In the past, ALIT has traded within the current range of 11 to 14x, and it is now trading at 12x, which is the average. I don't think it is likely for ALIT to trade back to pre-2022 levels as the valuation paradigm has changed significantly due to the change in interest rates.

Summary

I maintain a buy rating for ALIT and the recent dip in share price presents a favorable buying opportunity. While the revised BPaaS bookings guide may cause short-term volatility, indicators such as revenue growth and EBITDA margin expansion remain robust.

For further details see: