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Morningstar | Cloud Reacceleration Drives Strong Start to 2019 for SAP; Raising FVE to EUR 116

Narrow-moat SAP highlighted its first-quarter 2019 earnings by reporting a reacceleration in its cloud business. Cloud revenue came in north of EUR 1.5 billion, up 45% over the same quarter last year and 11% sequentially. Forty-five percent cloud revenue growth is a reacceleration from the 33% cloud growth in 2018. We believe the strong growth in the cloud business is due, in part, to the restructuring plan SAP announced at the end of 2018. As part of the restructuring, SAP is allocating more resources to its higher-growth businesses like cloud, which gives us increased confidence in the long-term prospects for the business. With SAP’s ERP offering, recent cloud acquisitions like Qualtrics and CallidiusCloud, and restructuring effort, we believe SAP has a large runway for organic cloud growth through the next decade and is aligning its resources accordingly to support the business transition. As a result, we are increasing our fair value estimate to EUR 116 per share from EUR 88. Shares have reacted positively to the news, up over 12% and fairly valued, in our view, at EUR 114 per share.

Total revenue was up 16%, surpassing EUR 6 billion, with strong results also outside cloud. Software licenses revenue and software support revenue, which have been flat over the last two years, showed strength, growing 4% and 7% year over year, respectively. First-quarter 2019 results received a bump from Qualtrics and CallidiusCloud, which were not included in 2018 first-quarter results. We believe SAP is well positioned to exceed its 2019 cloud subscriptions and support revenue and cloud and software revenue targets of EUR 6.9 billion and EUR 22.6 billion, at their midpoints, respectively. Operating margins for the quarter came in at negative 2%, due to one-time charges for restructuring and share-based compensation, and non-IFRS operating margins were 24%. Management did slightly increase its guidance for operating profits for the year.

Management left 2020 and 2023 ambitions largely unchanged. The company maintained an outlook of EUR 8.6 billion-EUR 9.1 billion in cloud revenue and EUR 28.6 billion-EUR 29.2 billion for total revenue in 2020. For both time frames, management increased margin targets slightly. For 2023, management is expecting non-IFRS gross margins of 75% and 500 basis points of non-IFRS operating margin improvement over 2018. Those numbers came in at 63% and 29%, respectively, in 2018. We believe that SAP’s Qualtrics acquisition, which was an emphasis at February’s analyst day, will play a key role in customer conversations and driving cloud adoption through the 2023 ambition timeline. Additionally, Qualtrics’ strong gross margins, cited at 87% on the call, should help drive margin expansion. Margins should also increase from moving customers to HANA and reducing duplicate infrastructure costs and ongoing operational efficiency efforts. SAP has established a special executive committee to explore operational efficiency efforts, such as improving go-to-market strategies and emphasizing innovation, which should be beneficial to operating margins longer term.