SAPGF - SAP: In-Line Performer Going Into 2024 Downgrading To Hold

2023-11-29 12:04:47 ET

Summary

• We are downgrading SAP to a HOLD.
• The stock outperformed the S&P 500 by 25% since our Buy rating in mid-November last year and 16% since its 3Q23 earnings.
• We expect SAP will be an in-line performer going forward as we believe the stock has already priced in its cloud growth and a soft-landing scenario for the company.
• While we expect SAP S/4HANA's cloud backlog to remain strong, we expect backlog growth to moderate as customers rationalize their IT spend into 2024.
• We recommend investors stay on the sideline for now.

We're downgrading SAP ( SAP ) to a hold. The stock outperformed the S&P 500 by 25% since our buy rating in mid-November last year and 16% since its 3Q23 earnings. We now think our positive thesis of SAP experiencing higher Cloud revenue growth and ERP growth due to S/4 HANA has played out and been priced into the stock. We now expect outperformance to be moderate and SAP to be an in-line performer through 1H24 as we think the stock has already pre-emptively priced in its cloud growth and a soft-landing scenario for the company. The following outlines the stock's performance since our initial note.

SAP's financial results for the third quarter of 2023 showed a 16% increase in cloud revenue and a 19% increase in the current cloud backlog, reaching €12.3B. This performance, though robust, indicates a deceleration from the second quarter's 19% cloud revenue growth and 21% backlog growth. We expect backlog growth to moderate as customers rationalize their IT spend into 2024; Gartner reported global IT spending is projected to grow 8% in 2024, reaching $5.1T. We see enterprise customers continuing to rationalize their spend in 2024 as the market remains in a deadlock between a soft-landing scenario and a recession.

We continue to expect SAP HANA and more recent offering of SAP S/4HANA to meet the growing demand for businesses looking to pursue efficient digital transformation; SAP HANA is a database that runs the most up-to-date versions of SAP's software, specifically SAP S/4 HANA. Previously, all SAP software used to be run on third-party databases, including Oracle ( ORCL ), among others, so HANA acts as SAP's own in-memory platform that enables faster access to and analysis of data. We like S/4HANA but don't expect it to boost top-line growth through 1H24 due to macro uncertainty weighing on IT spend and causing customers to tighten budgets further. Despite the strong performance of SAP S/4HANA's cloud segment, with a 65% increase in the backlog, the broader moderation in IT spending growth could lead to more calculated and less aggressive expansion in this area. The following outlines SAP's 3Q23 financial highlights that outline the deceleration in growth.

While SAP continues to show strength in its cloud business, we see a potential moderation in its growth trajectory. Hence, we recommend investors stay on the sidelines. We remain bullish on SAP in the longer-term as we think the company is uniquely positioned to accelerate growth in a healthier macro backdrop and see the company's share of the ERP market expanding. We recommend longer-term investors begin exploring entry points into the stock through 1H24 opportunistically for longer-term returns.

Valuation

The stock is trading below the peer group average; on a P/E basis, the stock is trading at 23.0x C2024 EPS $6.15 compared to the peer group average of 28.0x. The stock is trading at 5.6x EV/C2024 Sales versus the peer group average of 6.1x. We understand that SAP's valuation is attractive at current levels; the stock is cheap compared to the peer group average. Still, we recommend against buying the stock on weakness as we think the stock won't work in the near-term. We recommend investors stay on the sidelines.

The following chart outlines SAP's valuation against the peer group average.

Word on Wall Street

Wall Street leans more towards a bullish sentiment on SAP. Of the 30 analysts covering the stock, 21 are buy-rated, and the remaining are hold-rated. We attribute Wall Street's bullish sentiment to the longer-term outlook on SAP in the ERP space as enterprise spending rebounds next year. We're less optimistic about the stock as we think it's already priced in its cloud growth and a soft-landing scenario for the company.

The stock is currently priced at $142 per share. The median sell-side price target is $145, while the mean is $140, with a potential upside of 1% to 2%. The following graph outlines SAP's sell-side ratings and price-targets.

What to do with the stock

We're downgrading SAP to a hold. We think the macro backdrop won't favor SAP's business in the near-term as we expect customers to normalize spending further in 2024. We now see outperformance moderating materially in 1H24 and expect SAP to be an in-line performer going forward. We recommend investors stay on the sidelines for the near-term.

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