As some of you may now, SAP SE reported their third quarter earnings yesterday morning and the SAP share price dropped immediately with around 18%. It even got worst during the day, because at the closing of the stock market the shares traded for 97.50 Euro a piece, a drop of a whopping 22%!
Ouch, that hurts when you’re a short term trader or investor who was anticipating on at least a decent uptick. I guess the CEO of SAP will neither sleep well after seeing almost a quarter of its market cap evaporating in just a few hours (~30 bln down the drain).
But hey, remember:
- we don’t trade, we invest.
- we are in it for the long-term and we see such kind of dips as a potential opportunity to buy!
And as the good old saying goes: price is what you pay, value is what you get
So let’s explore this a little bit: is there value by initiating a position in SAP right now?
I’m going to give you my opinion here without doing a full analysis regarding different aspects of the company and the stock. I am just trying to give a quick reaction related to the market action from yesterday, because several readers have reached out to me about my thoughts regarding SAP share price.
Is SAP a quality company?
Yes, it is!
But isn’t SAP the ERP vendor of this software in our company that everyone complains about?
Yes, it also is!
Many people know SAP from these cumbersome and long implementations that typically take longer than planned and typically cost more than budgeted.
I know a bit about this, because I’ve spend my fair time in IT and in close proximity to SAP consultants. While it’s true that SAP hasn’t got a perfect branding regarding usability, it would neither be fair to say that the reputation is solely due to their software.
Actually, over the years many of the people I know started to appreciate SAP more and more. The reason for that is simple: try to name more than three competitors to SAP which can deal with the full spectrum of complex and integrated core company processes?
Workday, Oracle, SalesForce: yes, they are very strong competitors, but this is not a winner-takes-all industry. Just google and you will see that SAP is named as a leader in many magic quadrants published by Gartner, and rightly so.
Having said that, SAP has a moat which is not too much different than Salesforce. Once your business is running on SAP it will be really hard to change the platform and switch vendor. Actually, switching costs are so high and so risky that it might even put a company’s business at risk.
And this is what is benefiting SAP tremendously today, because they’ve been building up their customer base for the last 3 decades. And this was not easy, just trying to get SAP implemented fully within your business might already put your business at risk.
The reason for that: SAP is really a digital solution for many of the core processes within a company. Just think about the support of resource planning, logistics, pay-rolling and managing purchase orders. For some companies just a few hours of downtime can cost them 10’s of millions.
These processes are so complicated and they often require lots of data and integration points between the processes. I actually don’t think that there are many companies other than SAP, Oracle and Salesforce that can support the larger companies in this world. No, Workday not yet, because it’s still in its early days with the amount of features and processes it supports.
Hence, this is why I believe that SAP has a really wide moat, even though the poor reputation in usability might be considered as working against them. Although I would argue that this was rather the state of their software from several years ago (which you might be still using today). The last few years they have heavily improved in their User Experience.
Does SAP have any catalysts?
Definitely! It can almost be summed up in a simple theme: Digital Transformation
Many large enterprises have spent the last decades digitizing their processes. With that they have reaped tremendous benefits, especially in costs savings if we think about it from an ERP perspective.
But this is not enough. New market entrants like Workday show that the next wave is really about digitalization of the core processes within an enterprise. What’s the difference between digitizing and digitalization?
With digitizing companies are literally one-on-one trying to use IT solutions to support their process without any adaptation. This is why for instance so many solutions are hard to implement, because many manual processes are far from standardized and contain a lot of preferential task execution.
Hence, digitalization is different, because it requires the enterprise to adapt their processes via standardization. It also requires a different approach to process execution to reap the full benefits of digitalization.
This is actually often not even a choice for most enterprises, because nowadays many of the new challengers in the industry are digital native companies. They took the power of a digital business from the start and and they are excellent in using of-the-shelve cloud solutions. This is where the real cost-efficiencies kick-in and what we call a Lean Digital Enterprise.
SAP understands this and is focusing a lot on transitioning their current customer base into the cloud. This has 2 main benefits to the customer:
- total-cost-of-ownership is expected to be lower, because the customer can reduce the amount of resources and time spent when SAP starts looking after upgrades and such
- it’s an opportunity to align enterprise processes with out-of-the-box features as they’re moving into the cloud already: hence a huge step as part of digital transformation.
To me this is the biggest catalyst for SAP: getting their customer base migrated into the cloud.
It provides a more predictable stream of revenue and allows them to increase margins over time, because they will be more in control over the solutions. DevOps and such concepts allow them to automate as much as possible.
Another big catalyst is the general expansion of the total addressable market. Market predictions show that just the ERP market alone is to double between 2018 and 2026. Even if SAP can’t acquire the same amount of customers like SalesForce, then there’s still ample room to take their own part of the market.
Luckily for SAP there’s also enough competition to prevent this from becoming a monopoly in case they would be at the inferior end of it.
Why is the SAP share price down with ~22%?
A picture speaks 1000 words right?
I would say that there are two main components to the SAP share price reaction from yesterday.
Firstly the company lowered their forward guidance by approximately 5%:
This came as a surprise to many analysts. I would like to challenge those analysts a bit, because one of the reasons SAP is bringing up is the impact of Covid-19 in Q3 and Q4 of this year due to the second wave which is currently ongoing in Europe.
I mean, followers of this blog has heard me many times saying that a second wave is really likely. Analysts and investors could’ve anticipated on this a bit better if they did some proper risk management. The same applies to SAP’s board of directors. They could’ve also anticipated on this better. I guess they were all fooling themselves here.
Maybe needless to say, but Covid-19 has quite some impact on SAP. One of their top products is called Concur. It’s a travel and expenses solution used by many Fortune 500 companies. Well, guess what: business travel and related expense management is one of the main use cases for this product. 85% less business travel means less usage of SAP’s product.
This is just one example where Covid-19 has a strong impact. Another impact is that some large companies are currently in cost-cutting mode and they are unlikely to start new big IT projects like upgrading for instance their SAP software.
Hence, this is probably the main reason why SAP reduced their forward guidance, because it impacts their ability to migrate as many customers as possible as soon as possible to the cloud.
A second reason why analysts where generally not happy with the results was the pretty flat sales compared to last year.
Adjusted for currency effects, sales remained stable at 6.54 billion euros from July to September. Adjusted for currency effects, operating profit rose by 4 percent to just under 2.1 billion euros. The bottom line, however, is a 31 percent increase in profits to 1.65 billion euros. This was mainly due to a valuation effect at the investment subsidiary Sapphire Ventures, which invests mainly money in start-ups.
So in my opinion these were probably indeed not suburb results, because SAP effectively failed to capture enough from the lockdowns and the rapid transition in digital transformation as some other typical growth stocks were able to do.
However, this in itself really doesn’t warrant a 22% price drop for me.
Unless, the stock was heavily overvalued and priced for perfection. So let’s have a quick look into SAP’s fair value then to assess it against the current SAP share price 😉
My thoughts on their fair value i.r.t SAP share price
Let’s do the math again using the Dividend Discount Model and a back on the napkin Free Cash Flow calculation. In the end, a good company with strong catalysts doesn’t necessarily make it a good investment at the current price level.
According to the Dividend Discount Model, the company should currently be valued at 79 Euro.
According to the Discounted Cash Flow model the stock should be valued at ~61 Euro.
You might think now: wow, that’s still a big gap between the current share price and the DCF value. True and this is where you can see that Tech stocks have generally outperformed the market.
Just to keep our heads cool: look at the below 10 year price graph and at the same time compare it to the table of 10 years earnings and free cash flow development. What you will quickly see is that the share price follows a totally different trend than earnings and cash flow growth.
And Cash is King, so FCF really matters here.
All in all I think that the fair value of SAP is probably somewhere around 70 Euro when taking both the DDM and the DCF calculation into account.
This means that the stock is still approximately 40% overvalued for me.
Last but not least, from a Technical Analysis point of view we can see that this will be a really interesting time for the stock price. The stock is about to dip below a 6 year long uptrend and it might drop further to the high eighties / low nineties if it fails to bottom out at the current price level.
I believe that SAP is a strong European company with a wide moat. I’m not too concerned about their ability to grow their earnings and cash flow over the upcoming decade.
Covid-19 is a strong headwind though regarding their ambition to increase their share of revenue from cloud significantly over the next 5 years. Hence why we’ve seen this price action yesterday.
Nevertheless I do think that the company is highly valued and not attractive at all yet at the current SAP share price.
Having said that, I did buy 4 shares yesterday so that I start keeping a closer track on it’s performance. SAP SE is part of my desired portfolio and I would need up to 50 shares to make it a full tier-4 position.
This purchase might seem contradictory to my conclusion, but 4 shares is not a position for me. It just means that it’s in my portfolio right now, so that it triggers me to start paying attention to it.
I hope that you found this article useful and that you got better insight in the SAP share price drop and whether it’s worth for consideration right now.
I intend to give a quick reflection more often. It’s just hard to do it during these busy weeks, because there’s just so much going on during the midst of earnings season.
Having said that, enjoy the remainder of this week and be in touch 👍
European Dividend Growth Investor
I’m not a certified financial planner/advisor nor a certified financial analyst nor an economist nor a CPA nor an accountant nor a lawyer. I’m not a finance professional through formal education. I’m a person who believes and takes pride in a sense of freedom, satisfaction, fulfillment and empowerment that I get from being financially competent and being conscious managing my personal money. The contents on this blog are for informational and entertainment purposes only and does not constitute financial, accounting, or legal advice. I can’t promise that the information shared on my blog is appropriate for you or anyone else. By reading this blog, you agree to hold me harmless from any ramifications, financial or otherwise, that occur to you as a result of acting on information provided on this blog.