2023-03-09 16:50:01 ET
Summary
- Shares of SAP have jumped 15% year to date, in line with many other tech stocks.
- Revenue growth in the recent fourth quarter missed expectations, however, as macro slowdowns impacted sales cycles.
- On a constant-currency basis, SAP would not have grown revenue at all.
- Though we're impressed by SAP's commitment to its long-term "2025 Ambition" plan, the stock is fully valued at ~19x forward P/E.
Amid continued volatility in the market after this year's early rebound, constant portfolio-watching is critical in order to beat the markets. 2023 is an excellent time to be a stock-picker, as the dominance of large-cap tech stocks within the S&P 500 is beginning to fade and small/mid-caps have the upper hand.
In particular, it's worth looking at the merit of keeping SAP ( SAP ) in our portfolios. While I was largely bullish on the company in 2022, after a healthy YTD appreciation / upward multiples re-rating amid soft business results, I'm more keen to move to the sidelines.
I have sold out of my SAP stake and am now neutral on the name. In my view, it's a much better juncture right now to divest out of large-cap companies (especially SAP as it weathers macro headwinds and potential reversal of the FX trends that benefited revenue so nicely in 2022) and put more into small/mid-cap names that are trading at better valuations.
Though I view SAP's fundamentals as a relatively balanced bag of positive and negative drivers (more detail on these in the following sections), it's primarily valuation that keeps me to the sidelines. At current share prices near $117, and versus current Wall Street consensus calling for $5.81 in pro forma EPS for FY23 (data from Yahoo Finance ), SAP is already trading at a 20.2x FY23 P/E multiple.
Considering so much of SAP's current revenue "growth" comes from favorable FX movements (which may dissipate if the euro strengthens), I'm wary of buying into SAP at a premium multiple when so many other tech stocks remain cheap (several favorites at the moment include Palantir ( PLTR ), Asana ( ASAN ), and Okta ( OKTA )).
The bright side: 2025 ambition remains intact; efficiency plays, and potential Qualtrics sale
Let's now discuss some of the drivers in SAP's favor at the moment.
The first good news: at the very least, SAP is still driving fairly strong growth in the cloud. As a reminder, SAP was a fairly late adopter of the cloud and subscription-based business model; but it has driven consistent double-digit growth over the past several years. The company's FY23 outlook calls for cloud revenue to grow at a 22-25% y/y clip this year, compared to just 6-8% y/y growth in software revenue overall.
Economies of scale in the cloud have also driven boosted cloud gross margins, which in turn are helping to drive total company profits upward. Operating profit guidance for next year is up 8-10% y/y, faster than revenue growth and implying margin progress.
And in spite of tougher macro headwinds that have forced sales cycles to elongate across almost every software company, SAP is still committing to its "2025 Ambition Plan" which calls for ?22 billion in cloud revenue by 2025, representing a 21% CAGR from 2022-2025.
Cloud aside, another piece of positive news that the markets may like is that the company may get an injection from a possible sale of Qualtrics . The most recent offer from private equity values Qualtrics at $12.4 billion, which means under SAP's stewardship the company has grown by more than 50% value since SAP acquired it in 2018 for $8 billion.
Lastly, following in the footsteps of many other companies in these tough times, SAP may get a boost as well from cutting jobs . The company is currently planning to let go of 3,000 employees (roughly 2.5% of its global workforce), which is helping to achieve the operating margin accretion that it's targeting for FY23.
The red flags: FX may stop being a tailwind; macro headwinds have no end in sight
It's not all good news for SAP, however. One of the red flags that I'm most concerned about is that SAP's current growth rates are buoyed by favorable FX movements. Since SAP reports in euros, the company enjoys a tailwind from recent dollar strength whereas most U.S.-based companies are reporting severe FX headwinds.
With the Fed's surprisingly hawkish remarks that have pushed the 10-year yield to 4%, the dollar has continued to rally, but if this trend reverses, SAP's results will optically decelerate. For example in Q4, as shown above, SAP's cloud revenue grew 30% y/y on an as-reported basis; but on a currency-neutral basis, that growth was only 22% y/y. Similarly, total revenue was up 6% y/y as-reported, but flat at 1% y/y at FX-neutral.
Some analysts are skeptical on SAP's ability to hit targets in FY23; as the company's 22-25% y/y cloud growth rate (on a constant-currency basis) implies acceleration from Q4's 22% y/y FX-neutral cloud growth rate. In response to this line of questioning on the Q&A portion of the Q4 earnings call , CFO Luka Mucic noted that management is expecting that acceleration to kick in the first quarter itself:
When we think about 2023, I would expect general re-acceleration throughout the year already starting in Q1 because of the strong backlog that we have been building that always comes into the revenue lines with one to two quarters of delay. And so you should see already a reacceleration in Q1 that would then further build up during the year. I'm sure there will be more questions around seasonality, but I'll leave it on that comment for cloud revenues. And then in terms of the forward-looking momentum, I think Christian has already talked about the great success that we had with BMW, the signing yesterday."
In my view, this is a very aggressive assumption against an uncertain macro backdrop. SAP is one of very few cloud companies to not forecast deceleration in 2023, and though we haven't yet seen the first quarter of 2023 play out yet, SAP's valuation right now may be propped up by lofty expectations it may fail to hit.
Key takeaways
If your investment horizon in SAP is 3+ years, it's fine to hold onto this stock and close your eyes. But if you're keen on stock-picking this year, I think SAP is edging on overvalued territory and is unlikely to dramatically beat expectations this year, owing to already-aggressive cloud growth targets. Investors should have a chance to pick up this stock at a lower price down the line.
For further details see:
SAP: Safer To Move To The Sidelines