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SAP: An Undervalued Software Goliath 

SAP is a leader in enterprise software 

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May 13, 2022
Summary
  • SAP customers generate 87% of commerce globally ($46 trillion).
  • 99 of the 100 largest companies globally are SAP customers.
  • SAP has forecasted 28% net profit growth annually over the next five years.
  • Free cash has doubled over the past 2 years.
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SAP SE (

SAP, Financial) is an enormous multinational software company which was founded in Germany in 1972. Since their IPO in 1988, the stock price has increased by over 652%.

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Over the past couple of years, the share price has been very volatile, and since October 2021, it has slid down by 33% alongside the general tech-led market selloff. More recently, the company is expecting their exit from operations in Russia to result in a 300 million Euro ($312 million) revenue hit and negatively impact operating profit by €350 million.

Despite the headwinds, the company is still dominating the enterprise resource planning software industry, and they currently serve 99 of the 100 largest companies globally. In addition, the global enterprise application market is forecasted to expand to $527 billion by 2030, growing at a CAGR of 8.2% over the period. This is expected to be a strong tailwind for the company.

Business model

SAP is a German multinational software company. It is the largest company in Germany by market capitalization and the third largest pure software company globally. They operate in over 180 countries, employ over 100,000 people and have over 425,000 customers around the world.

They are most famous for their enterprise resource planning software, which helps businesses view and manage their business resources such as cash, inventory, production capacity, etc. while also allowing them to gain insights into purchase orders, payroll and much more.

The company also offers products to help with other main business functions, including the following:

  • Customer relationship management software
  • Financial management
  • Supply chain management
  • Human capital management
  • Spend management
  • Business technology platform

SAP is currently transitioning from an “old school” license-based model, which is notoriously volatile, to a software-as-a-service (SaaS) model. Geographically, the company has an extremely diverse revenue base with 44% from the Europe, Middle East and Africa region and 41% from the Americas.

Financials

SAP’s traditional license-based model is notoriously volatile. In 2020, revenues declined to €27.3 billion from €27.5 billion in the year prior. Although this wasn’t a major decline, any decline is bad in the eyes of Wall Street and can keep valuation multiples depressed. The good news is the company has some superb gross margins upwards of 70%, which has been fairly stable over the past few years. This has created more stable top and bottom lines than many other license-based revenue models.

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The company is currently investing between €4 billion and €5 billion in R&D each year. SG&A expenses were even higher in 2021 at €9.9 billion. This leaves an operating margin of 17%, which did have a slightly dip in 2021.

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Free cash has doubled over the past two years from €2.6 billion for fiscal 2019 to €5.4 billion for fiscal 2021. However, there was a large dip in 2020, which plays into the company’s volatile story.

The company has shown strong momentum in the first quarter of 2022, with cloud revenue popping by 34% and their S/4 HANA cloud product proving to be very popular (this product alone saw its revenues up 78%). Earnings per share did decline by 29%, which was a negative sign, and the company is expecting their exit from Russia to continue to weight on results with a €300 million revenue hit.

The good news is they are forecasting earnings per share to bounce back for full-year 2022 and have recently raised estimates to €4.05 per share. The dividend yield is currently at 1.63%, and they aim to start to decrease debt between 2023 and 2025.

Valuation

In terms of valuation, SAP is trading at an enterprise-value-to-Ebitda ratio of 11.43, which is below their long-term average.

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The GF value line, a unique intrinsic value model from GuruFocus, indications the stock is modestly undervalued.

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The major risk I can see for this company is from high competition in the industry. I'd be on the lookout for competitors such as Dassault (

DASTY, Financial), Sage Group (SGPYY, Financial), Software AG (FRA:SOW, Financial), Microsoft (MSFT, Financial), Salesforce (CRM, Financial) and Workday (WDAY, Financial).

Nevertheless, SAP's cloud based platform has proven to be immensely popular with customers. Their newer SaaS business model should help to create smoother revenues in the long-term, which is a positive for investors. The stock also appears to be undervalued relative to historic multiples and GF Value.

Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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