2023-04-22 08:33:01 ET
Summary
- SAP's 1Q23 results exceeded expectations, with strong revenue and EBIT growth driven by licensing and cloud revenue.
- The company's S/4HANA CCB expansion and improving cloud gross margins suggest resiliency in the face of a tepid macro environment.
- SAP is a good bet to benefit greatly from the long-term trend of growing IT budgets for secure and scalable cloud infrastructure.
Thesis
While SAP (SAP) is likely already familiar to most investors, for the benefit of any newcomers: The enterprise resource planning [ERP] software solution that has made SAP famous is rivaled primarily by Oracle (ORCL). SAP is a company I recommend buying because I anticipate further expansion thanks to the company's strong back-end operations and the ongoing S/4HANA upgrade cycle. Investors may be enticed back into the SAP stock if the company's equity narrative profile is transformed from one of declining or stagnant EBIT business to one with double-digit profit growth. The sale of the Qualtrics stake also frees up cash that could be distributed to the company's stockholders.
1Q23 results
Both revenue and EBIT for SAP's 1Q23 were better than expected. To zero in on one particular area that came in significantly ahead of expectations thanks to better-than-expected execution in the quarter: licenses. Cloud revenue growth is also strong, at 22% on a PFCC basis (pro forma and constant currency). Profitability wise, the quarter's EBIT PFCC growth of 12% was above forecasts, largely due to the licensing revenue beat. Meanwhile, S/4HANA CCB remained strong, coming in at 78% yoy CC, and Current Cloud Backlog [CCB] growth came in at 25% yoy on a constant currency [CC] basis, which is generally in line with growth from prior quarters. S/4HANA CCB expansion is a clear indication of resiliency in the face of a tepid macro environment. Cloud gross margin improved to 71.4%, an increase of 250bps on a like-for-like basis, indicating margin expansion. As the expenses associated with the harmonization program are anticipated to decrease, I have faith that the trend of increasing margins will continue.
SAP has reaffirmed its guidance for the FY23 impact of deconsolidating Qualtrics from continuing operations. In my opinion, the 25% quarterly growth in CCB CC will support management's forecast of 23%-26% growth in PFCC cloud revenue in FY23. I think it's reasonable to expect operating profit PFCC growth in the range of 8%-11%, which would imply margins of around 27.7% to 28%, given that the two main drivers of this trend are the expansion of cloud gross margins and the optimization of the cost base (through the reduction of personnel, for example). Also in line with consensus was the FCF FY23 guidance of EUR 4.9 billion. Management has also confirmed that new medium-term goals will be introduced at the SAPPHIRE NOW user conference in May. Given the shifting macro backdrop, momentum in the migration of existing large, and the development of CCB, I believe this conference could be a key catalyst to a positive re-rating of the stock price. In addition, I'm hoping to learn more about efforts to increase cloud gross margins and optimize their cost bases. Together, these would give investors a more direct path to FY23 guidance and a sharper center of attention on revised goals for FY25.
Growth opportunities
After customers have made the transition to the cloud, I believe there will be ample opportunities for cross-selling and up-selling throughout the entire portfolio. The Chief of Customer Success (Scott Russell) echoes this, saying that "the multiples are undeniable." Crucially, I think demand is still high. I think it's safe to say that the importance of a company's mission-critical workflows, data, and processes is growing. Companies want to expand profitably, so they must ensure that the cloud services they use for their IT infrastructure are secure, scalable, and cutting edge. SAP is one of the most well-known names in the industry, so they are a good bet to benefit greatly from this long-term trend. SAP has also said they expect a prosperous year ahead, citing a robust pipeline. Finally, I think SAP can use the proceeds they made from the sale of Qualtrics to make strategic acquisitions that will boost their top line and improve their technology stack.
Guidance
The CEO's tone on the earnings call gave me a lot of faith that SAP would be able to achieve its double-digit growth guidance. The CEO has expressed optimism regarding double-digit revenue growth beginning in 2024 and continuing into the foreseeable future. I think it's important to point out that SAP is already producing 9% CC growth in the quarter. As previously stated, I believe that it is quite possible to achieve a growth rate in the double digits, mainly due to the momentum of cloud, a greater proportion of revenue generated by cloud services
Risks
While I agree that SAP's product solutions are based on a solid foundation, I worry that they are vulnerable to the deteriorating macroeconomic conditions we are currently experiencing. All of these factors may have an effect on IT spending by corporations, which in turn may affect SAP's business prospects. In addition, SAP continues to face stiff competition from a plethora of SaaS companies that have developed formidable offerings in the CRM, big data analytics, etc. markets. Customers may put off or refuse the upgrade because of the S/4HANA transition, and in the worst-case scenario, they may look elsewhere for ERP software.
Conclusion
In conclusion, SAP's 1Q23 results exceeded expectations, with strong revenue and EBIT growth driven by licensing and cloud revenue. The company's S/4HANA CCB expansion and improving cloud gross margins suggest resiliency in the face of a tepid macro environment. While SAP faces competition from SaaS companies and potential IT spending slowdowns, I believe the company's strong back-end operations and ongoing S/4HANA upgrade cycle position it for further expansion. The recent sale of Qualtrics also frees up cash that could be distributed to stockholders or used for strategic acquisitions. With management reaffirming guidance and expressing optimism for double-digit revenue growth in the coming years, I recommend buying SAP stock for long-term investors looking to benefit from the growing importance of mission-critical workflows, data, and processes in the IT industry.
For further details see:
SAP: Expecting Double Digits EBIT Growth From FY24 Onwards