Argus upgrades SAP to 'Buy' with target price of $240

Investing.com - In an research note released on Wednesday, analysts at Argus announced an upgrade of SAP SE ADR (NYSE:SAP) to a 'Buy' rating, setting a new target price of $240.

In the second quarter of 2024, SAP demonstrated a significant 35% increase in pro forma operating income and a 10% boost in revenue, while pro forma EPS saw a remarkable rise of 60%.

Argus analysts highlight SAP’s evolving business strategy, which shifts focus to cloud services as the traditional license business declines. AI applications and business transformation initiatives are key facets of this new direction.

Although Argus has lowered its 2024 EPS estimate to $5.34 from $5.61, it maintains its 2025 forecast at $6.78. This adjustment is attributed to accounting changes related to the Qualtrics spin-off and currency fluctuations, rather than operational performance.

Investment Thesis

Argus believes SAP has successfully transitioned its business model, leveraging cloud-based revenue and improving margins despite the decline in on-premises software licenses. The firm is optimistic about SAP’s ability to capitalize on digital transformation and cloud migration trends among its enterprise clients. Significant restructuring initiatives are also expected to further enhance margins.

SAP’s goal is to enhance clients' experiences through digital transformation, with AI being a crucial component. The company’s S/4 HANA Cloud system, combined with various business-process applications, supports cloud-only or hybrid solutions. This versatility is expected to appeal to a broad range of enterprise customers.

Argus notes that SAP shares have become more valuable in 2024 due to strong operational returns, with the expectation that this trend will persist into 2025.

Recent Developments

On July 22, SAP reported its Q2 2024 results. Revenue increased by 10% year-over-year to 8.3 billion euros, driven by a 25% rise in cloud sales. However, the increase was offset by a 28% decline in software licenses and a 3% decline in software support. Overall, the software licenses and support segment dropped by 5% to 3 billion euros, while services revenue rose by 6% to 1.1 billion euros. The pro forma operating income increased by 35% in constant currency, improving the operating margin by 410 basis points to 23.4%.

Pro forma diluted EPS attributable to SAP rose by 60% year-over-year to 1.08 euros. Using International Financial Reporting Standards (IFRS), SAP's EPS from continuing operations increased to 0.75 euros from 0.62 euros in the same quarter of the previous year. SAP incurred restructuring charges amounting to 2.9 billion euros in the first half of 2024, including 600 million euros in the second quarter as part of its business transformation initiatives.

The current cloud backlog reached 14.8 billion euros at the end of Q2 2024, up 28% year-over-year, indicating a strong near-term revenue pipeline despite decreases in on-premises software licenses.

SAP is also actively pursuing growth through acquisitions and new product launches. On June 5, the company agreed to acquire WalkMe Ltd. for approximately $1.5 billion. WalkMe’s digital adoption platform enhances digital workflows and SAP expects the acquisition to close in Q3 2024. Additionally, SAP launched Joule, an AI co-pilot tool, with integration across its cloud enterprise portfolio.

Earnings and Growth Analysis

Argus has adjusted its 2024 EPS estimate for SAP to $5.34, down from $5.61, but maintains its 2025 forecast at $6.78. The earnings growth rate is projected at 13.5% over the next two years, significantly above the long-term growth rate of 6%.

SAP has ambitious targets to generate over 37.5 billion euros in revenue and 10 billion euros in pro forma operating profit by 2025, leveraging substantial investments in AI and business transformation.

Financial Strength and Dividends

SAP’s financial strength is rated “High” by Argus, supported by strong credit ratings from S&P and Moody's (NYSE:MCO). SAP paid an annual dividend of $2.39 per share in May 2024, with projections for a slight increase to $2.52 in 2025. The current dividend yield stands at approximately 1.1%.

Valuation

SAP's shares have outperformed major indices, gaining 34% year-to-date compared to a 25% rise for the S&P 500. The forward enterprise value/EBITDA multiple of 23.5 is 17% above the peer average.

Argus has upgraded its rating on SAP to 'Buy,' with a target price of $240, based on the company's promising transition and growth prospects in cloud computing and AI.