One of the largest European company, German software provider SAP is a leader in enterprise application software, database, analytics, intelligent technologies and experience management. Clients can choose to run their business in the cloud, on – premise or in hybrid model.

The name SAP stands for Systems, Applications, Products in data processing. It has 437K customers in 180 countries and 200 Mln cloud users worldwide. SAP core system is ERP – Enterprise Resource Planning system.  Recently company introduced the new cloud ERP system, S/4. It is run in combination with SAP HANA database. Artificial Intelligence and Machine Learning are part of all the business processes. The company has master agreement with Microsoft with respect to SAP Cloud Platform.

SAP has the following activity segments:

  • Application, Technology and Support (AT&S) – the largest segment, consisting of SAP S/4HANA, Human Experience Management (HR solutions), SAP Customer Experience, SAP Business Technology Platform and Ariba & Fieldglass.
  • Concur – provides integrated travel, expense and invoice management solutions.
  • Qualtrics – solution that enables companies design and improve the four core experiences of business: customer, employee, product and brand. Qualtrics was acquired by SAP in 2019.
  • Services – provides support for their software and technology.

In January 2021 the company launched “RISE with SAP”, a commercial package with one subscription fee, allowing customers to transition their systems to the cloud. SAP Business Technology Platform is a central element of it.

On January 28 successful IPO of Qualtrics took place where the company was valued almost USD 18 B, more than double the original acquisition price.

In 2019 the company introduced a 2023 ambition (it became “2025 ambition” after SAP performance was hit by the pandemic). The company expects more than triple cloud revenue (since 2018) and reach cloud gross margin of 75% (now it is 66.5%). This push for cloud should lead to more stable and consistent performance in the future.

   Revenue

In the past the company’s revenue has been on solid foot, growing over 9% on average each year over 5 years. Key revenue drivers are cloud revenue and software revenue as they affect other revenue streams.

For 2020 revenue is down 1% to EUR 27.34 B. The share of predictable revenue is 72% (predictable revenue consists of the cloud revenue and the software support revenue). 2020 was a strong year for the cloud business with revenue up 17%. The cloud revenue consists of fees earned from SaaS (Software as a Service), PaaS (Platform as a Service), IaaS (Infrastructure as a Service) and Premium fees.

In 2021 the company expects that the pandemic related crisis would begin to recede leading to improving demand in the second half of 2021. In 2021 it expects 13% – 18% increase in cloud revenue and flat result in cloud and software revenue. Predictable part of revenue should reach 75%. The move to cloud remains the main focus of the company. That will limit total revenue growth temporarily but benefit the company in the long term.

   Profitability

Since 2015 EPS growth of SAP was smooth and trending upward. However in 2019 it was down almost 19% year – on – year as a result of Qualtrics acquisition charges (EUR 0.7 B) and SAP restructuring program costs (EUR1.13 B).

In 2020 operating profit is EUR 6.62 B, up 48% year – on – year. It is positively impacted by lower restructuring charges. EPS is EUR 4.35, up 56%. After the surge last year the company expects 1% to 6% lower profit this year.

In its 2023 ambition the company intended to growth operating profit around 11% each year until 2023. The pandemic and fast move to the cloud has lowered that ambition but it could still be expect single digit growth in company profits over the medium term.

   Dividends

The company has disciplined approach to capital allocation. Its dividend policy is to pay at least 40% of net profit in dividends. Since 2015 SAP has increased its dividend on 7.5% per annum on average. Dividend growth is smooth and steady as the company increases payouts every year.

Dividend is well covered by the company’s free cash flow (FCF) as FCF increased 164% to EUR 6 B due to lower taxes, lower restructuring payments and a successful working capital management. Dividend is also well covered by earnings as the payout ratio in only 36%.

However current dividend yield of 1.5% is low.

In the future we could expect that dividend would increase in the same consistent way but at the lower pace due to the crisis – related headwinds.

   Financial Strength

SAP’s Debt/Equity ratio of 44% is moderate. However its Net Debt/Equity ratio is much better, 21.7% as net debt is less than half of total financial debt due to the robust cash flow. Operating cash flow almost doubled in 2020 to EUR 7.19 B. It covers well SAP’s debt. The company’s long term and short term debt in total is EUR 13.283 B. So, operating cash flow is 54%, more than half of total debt.

Interest payments are also well covered by operating profit as coverage is 9.5x.

   Investment case

SAP’s share price was down 23% after reporting third quarter results as the company, hit by the pandemic, missed on revenue and reduced outlook for the rest of 2020. Since then stock price recovered only slightly.

Now we estimate how reasonable is the price of SAP using historical average P/E ratio. The following assumptions are made to project the stock price.

  • EPS growth is 5% per year in the coming 5 years period. So EPS would grow from current EUR 4.35 to EUR 5.55 in 5 years.
  • Dividend is EUR 1.58 per annum and remains the same in the coming years. So over the next 5 years the total dividend income would be EUR 7.9 per share.
  • Future buy backs are not taken into account (even though in April, 2020 company bought back its shares for EUR 1.5 Bln).

Multiplying future EPS (EUR 5.55) by the average P/E over the last 5 years (27.32), gives us the rough estimate what could be the stock price in 5 years period:

EUR 5.55 x 27.32 = EUR 151.63

That means SAP’s stock price upside potential is 44.6% from the current price of EUR 104.86 if our assumptions come true.

Taking into account the expected dividend income over the next 5 years (EUR 7.9), the overall return on investment, if the stock is bought today, with dividends not reinvested, could be around 52% over the 5 years period or 8.75% compound return each year on average.

Despite of economic uncertainties, customers are expected to continue investing in SAP products and services. Technology and its latest products will be used by customers to increase efficiency and competitiveness. However, the pandemic is still here and the pace of economic recovery is unclear. Prolonged recession could lead to slower profitability improvement. Also competition from other, more specialized technology companies could put pressure on SAP’s margins.

 

Notes

Source of pictures – the company website unless otherwise stated.

Colored circles next to headings mean an author’s evaluation of the relevant performance criteria of the company: green means positive, yellow neutral and red negative evaluation.

The estimates made in the article are for the informational purposes only. They are the result of the rule of thumb assumptions and the real outcome might differ materially from those estimates. As the future unfolds, macro events, not mentioned in the article, could impact the company fundamentals. Use the information in the article as a starting point for your own due diligence.

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