Over the past 10 years the SAP stock has gained 14 percent annually and has become the most valuable company in Germany. After all, as entrepreneur, investor and billionaire Mark Cuban said in 2017, “data is the new gold“. Is SAP a gold mine in this sense?
Day after day, huge amounts of data are created in large companies. SAP helps these companies to manage and analyse the data efficiently and to generate added value from it. Because without efficient data management, no company can be successful in today’s world. And digitization continues to advance. But what exactly is SAP doing? You can find out more about the business model and whether the SAP stock is a buy or not in this stock analysis.
SAP stands for systems, applications and products in data processing. The company develops software solutions that can be used in all business processes. This software is also known as Enterprise Resource Planning (ERP). Examples of this include proprietary modules for accounting, controlling, sales, purchasing, production, warehousing and human resources.
The company was founded in 1972 by five former IBM employees. In the early days, the first programs for payroll processing and accounting on mainframe computers were developed. Data was entered via screen and keyboard instead of mechanically punching it on punch cards. Therefore they called the software “Realtime”. The initial letter R is an integral part of the main products, such as SAP R1 in the beginning or the software that led to the great financial breakthrough: SAP R3.
|Market cap.||189,3 billion $|
|Dividend stability||0.98 of max. 1.0|
|Earnings stability||0.96 of max. 1.0|
SAP does not develop individual software, but standard software. Standard software refers to solutions that are not only specially produced for one company, but can be used by many companies with manageable adaptations. General advantages of standard software are low costs compared to a customised in-house solution and faster implementation. The costs are lower because the basic framework has already been programmed and the necessary adjustments can be implemented more quickly than developing a completely new software. A widespread example of standard software are Microsoft Office products such as Word, Excel and Powerpoint. With these products you can carry out a large part of the standard office tasks, but for the accomplishment of special tasks you need a tailor- made programme. Similarly broadly applicable in companies is SAP´s software. Because standard processes such as incoming orders, material requirements planning and invoicing run the same way in almost all companies and can therefore be mapped with one and the same software with certain adjustments. SAP customers also benefit from so-called best practice solutions. Thanks to many years of experience and cooperation with companies, SAP has been able to develop optimal procedures for standard processes in various industries. SAP offers a total of 25 different industry solutions to cater for industry specific requirements such as insurance companies, banks and retail companies.
What is special about SAP is that they were the first on the market to offer an integrated system. To illustrate this I want to refer to the example of a purchasing process below.
The process starts with the assessment of needs. The estimated demand is compared with the current stock level and in case of a shortage a procurement request is triggered. A budget is required for this, which must also be approved. The purchasing department must determine a suitable supplier with the best conditions and then place the order. In addition, it must be monitored whether the delivery deadlines are met. As soon as the material arrives at the warehouse, the goods receipt must be posted. At the same time, the supplier issues an invoice, which must be posted and paid. All these steps are mapped in the SAP system and can be carried out with so-called transactions. This means that the company does not need to use a separate system for requirements determination, supplier management, warehouse management and accounting. Furthermore, product calculations and budget planning can be carried out in the SAP system. Due to the widespread use of SAP, the functionality and handling of the system is taught in universities. SAP certificates are in demand on the job market, which I can report from my own experience. My certifications have enabled me to secure one or two internships and to work on exciting projects more quickly, as the employer does not have to provide extensive training in the SAP system.
For the SAP ERP product, maintenance will expire in 2027. As a result, all SAP customers will have to switch to the successor system SAP S/4HANA. The main innovation lies in the underlying database – an in-memory database. This technology makes it possible to keep the most important data in the RAM, thus enabling much better performance. More complex analyses and reports can be carried out with the new system within seconds or minutes, whereas the old system often required several hours or even the whole night. Material planning or quarterly financial statements can be available within minutes if the data is maintained correctly. New features in the user interface have also been implemented and the system has been adapted to mobile devices. Currently, almost 16,000 companies have switched over, but many customers are still waiting because the migration effort is high and has far-reaching consequences. In addition to the software, various business processes must also be adapted. The migration can be described as open-heart surgery, because it involves the system that manages all the data in the company and a small error can lead to an immediate shutdown. There is also criticism from customers who feel compelled to change over, even though SAP ERP is a tried and tested programme and often the budget for IT does not seem sufficient for this.
SAP systems can be used as cloud, on premise or hybrid solutions. On premise means installation on the customer’s own data centres and in a hybrid solution, part of the system is used in the cloud and a part is installed at the local data centre. A major advantage of increased cloud use is the ability to plan. Revenues from this area are based on a subscription model and are therefore almost 100% secure in the coming years. At SAP, the share of plannable revenue already amounts to 72 percent of total revenue. This makes major revenue losses increasingly unlikely, which should make you happy as a potential shareholder. The cloud division itself is also a growth driver. Between 18 and 24 percent growth is expected for the 2020 financial year. For a big ship like SAP, these are considerable growth rates.
The cloud business is expected to triple by 2023, with revenues rising from the current €28 billion to more than €35 billion. Despite the corona crisis, SAP confirmed its mid-term goals for 2023 and made only minimal downward adjustments to its short-term goals for 2020.
At this point, I will discuss the composition of SAP’s customer base because this shows how widespread the software is: 92 percent of Forbes Global 200 companies and 98 percent of the 100 most valuable brands use SAP. The customer base is not only large corporations, but around 80 percent of customers are small and medium-sized enterprises (SMEs). The software is used in a total of more than 400,000 companies. 77 percent of all transaction revenues worldwide are generated by SAP. In addition to the predictability provided by the cloud business, revenues are largely secure for another reason. The introduction of software in a company is associated with considerable financial expenditure, which can run into the millions. In addition, employee training and various process adaptations are also incurred by a company. You can imagine that switching away from a functioning system is not an everyday decision. If competitors such as Oracle or Microsoft “only” offer slightly cheaper or better solutions, this is by no means sufficient reason to change. In line with its large customer base, SAP has high market shares in the areas of enterprise applications (ERP), analytics, supply chain management and human resources management.
To maintain and expand this position, SAP is investing almost €4.3 billion in research and development (R&D). This results in an impressive R&D ratio of 15.5 percent. In terms of employee numbers, 27.8 percent of the global workforce is engaged in R&D. In addition to standard products, SAP also develops innovative products, especially in the areas of machine learning (SAP Leonardo), artificial intelligence and software-robot-supported process automation (RPA).
The founders of SAP hold an 11 percent stake in the company and thus continue to have a direct interest in SAP’s long-term business success. In addition, 73 percent of employees hold SAP shares, which is why 4 percent of the company is owned by employees. In my view, this is a very important point, as employee ownership changes the mindset. The employees see that the company is doing well on the stock market and that they contribute to it. Employees feel more motivated and can contribute even more to the company’s success. Of course, employees also benefit from stock price gains and rising dividends.
From the previous chapters it is clear that SAP operates in a very exciting and promising industry and has a strong market position. The key figures per share reflect this.
Except for a decline in 2019, earnings and operating cash flow per share developed from bottom left to top right. The forecasts continue to show a clear picture of rising profits and cash flows. The dividend is also set to increase further.
SAP is constantly increasing its revenue, which is not only visible on the dividend-screener graphically, but can also be read off using the key figure “stability of revenue”. This ratio is +0.97 out of a maximum of +1.0 and is an absolute peak value. The long-term growth rates of revenue are also in the high single-digit range and are also impressive.
The gross margin of almost 70 percent is as high as it is almost only for software companies. The operating margin, on the other hand, has fallen from 30 percent to just over 20 percent in recent years, but this is due to the switch to the cloud and the subscription model. In 2021, cost savings and more SAP S/4 customers are expected to return to old highs. Despite the Corona crisis, there was only a slight decline in revenue because no company can do without its central data management system. Employees continue to use the system even when they are in their home office. In addition, the licence agreements have been concluded for the long term. A short-term conversion or termination is simply impossible.
SAP pays out once a year. For fiscal year 2019, a dividend of €1.58 was paid, which represents a dividend yield of 1.2 percent. Management determines the dividend on a payout ratio of 40 percent or more of profit after tax. Thanks to its profitable business, SAP has been able to increase the dividend for 10 years and has not reduced the dividend for 26 years.
Due to the low dividend, SAP is perceived as a growth stock rather than a dividend stock. This is further indicated by looking at the dividend turbo which shows that the current dividend is at the lower end of the 12-month dividend corridor.
Despite the Corona crisis, SAP management is confident enough to further increase the dividend. Whether this optimism is reflected in a strong balance sheet will now be examined on the basis of SAP’s debt ratio and amortization power.
SAP’s balance sheet is solid and the company has sufficient cash on hand amounting to €6.2 billion. This allows the management to act flexibly and to finance potential acquisitions. The debt ratio has risen steadily in recent years from just under 40 percent to just over 50 percent, but it is still within the range and, in my view, there is no threat that SAP could run into financial distress in the near future. The development of the repayment capacity is also interesting as it has been increased despite the higher dividend. I think the dividend is safe and chances are good that it can be further increased in the coming years.
In addition to the dividend, there is also a share buyback programme, which was mainly exercised in the years before the 2009 financial crisis.
In 2020, treasury shares were bought back for EUR 1.5 billion at an average price of EUR 106. No further share buy-backs are planned for 2020. This enabled earnings per share to be increased by 5 cents. Not a particularly high figure for an expected profit of EUR 3.85 in 2020, but an interesting step nevertheless, because at EUR 106, SAP was quite fairly valued, as you will now see.
The business model, the earnings power, the growth – all these factors are in favour of buying SAP stocks. However, the valuation of the stock is still pending. After all, the market knows that SAP is a successful company. I determine whether the stock is currently cheap or expensive by using the Dynamic Fair-Value caluclator on Dividendstocks.cash. It refers to the balance sheet profit, the adjusted profit and the dividend.
The chart shows that until mid-2014, the SAP stock was undervalued because the price (the black line) was below the differently coloured lines that describe the fair value of the stock. Today, the fair values are €97 for the reported and adjusted profit and €105 for the dividend. With the recent rise in the stock price to EUR 135, the stock price has thus moved away from the fundamental valuation. A fair valuation at the current price would not be achieved until 2022, when the forecasted profit occurs, which seems very optimistic. In my view, the SAP stock is therefore unfortunately overvalued.
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SAP is certainly a very well-positioned company with promising products that are indispensable to most companies. I am also more positive that SAP will be in a better position in 10 years than it is today. And yet the stock price today is not a buy for me. In a kind of gold rush, the stock prices of the so-called profiteers of digitization are reaching dizzying heights sometimes. The SAP stock price has also been affected by this gold rush. Although the overvaluation is not as marked as for some other stocks, it is still there. However, I set myself a price alarm because I am convinced of SAP stocks as a long-term investment. An alternative to a one-off stock purchase at a very high price would be a stock savings plan, which would be executed monthly. If the SAP stock price returns to its fair value, you can continue to buy at low prices and thus benefit from the cost-average effect.
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