LLM And Generative AI Projects Will Secure A Bright Future

Key Takeaways

• Strong growth in generative AI projects and strategic positioning in key markets imply significant revenue expansion and diversified income sources.
  
• Operational efficiencies and cost reductions improve profitability and net margins, aligning with strategic expansion efforts in China and the U.S.
  
• Dependency on large contracts and short-term projects alongside low-margin growth in China and variable AI market dynamics pose risks to stable revenue and margins.

Catalysts

Operates as an AI lifecycle company that provides data sourcing, data annotation, and model evaluation solutions in Australia, the United States, and internationally.

• The impressive 71% revenue growth in China, driven by work with major LLM model builders and leading technology companies, suggests potential for future expansion and stable revenue in this critical market. This is likely to impact revenue positively.
  
• Appen's increasing involvement in generative AI projects, with 28% of H2 FY '24 revenue coming from this area (up from 6% in H2 FY '23), indicates strong growth potential in a rapidly evolving market. This is expected to contribute significantly to future revenue growth.
  
• The development and use of Appen’s AI data annotation platform, ADAP, for complex LLM projects highlight operational efficiencies and product enhancement, which could improve net margins through higher service demand and cost-effective project execution.
  
• Cost reductions, including a 26% decrease in OpEx from FY '23 to FY '24, coupled with structural changes such as establishing a technology hub in Hyderabad, have improved profitability. Continued cost discipline is expected to enhance earnings and net margins.
  
• The strategic positioning in both U.S. and China LLM markets enables Appen to capture growth from both sides and provides insights into the AI ecosystem, potentially driving diversified revenue streams and stable earnings.

Appen Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Appen's revenue will grow by 9.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from -8.5% today to 1.1% in 3 years time.
• Analysts expect earnings to reach $3.5 million (and earnings per share of $0.01) by about July 2028, up from $-20.0 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $15.0 million in earnings, and the most bearish expecting $-8.1 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 144.0x on those 2028 earnings, up from -10.3x today. This future PE is greater than the current PE for the AU IT industry at 34.6x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.22%, as per the Simply Wall St company report.

Appen Future Earnings Per Share Growth

Risks

• The termination of the Google contract led to a 14% decrease in total revenue, signaling a dependency on large contracts that, if not replaced, could impact future revenue stability and growth.
  
• China has shown impressive growth; however, the gross margins in this region are generally lower than in other divisions, which might negatively affect overall net margins.
  
• There is significant variability in project duration and volume in the generative AI market, which may result in inconsistent revenue streams and create challenges in forecasting earnings.
  
• Despite potential growth opportunities in China and the generative AI market, there is no explicit visibility on consistent long-term contracts, posing risks to sustained revenue and earnings.
  
• The focus on cost reduction and operational efficiency is crucial, but dependency on short-term high magnitude projects for growth could be vulnerable to rapid changes in client needs or market conditions, affecting net margins.

Valuation

• The analysts have a consensus price target of A$1.84 for Appen based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$2.7, and the most bearish reporting a price target of just A$0.55.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $307.4 million, earnings will come to $3.5 million, and it would be trading on a PE ratio of 144.0x, assuming you use a discount rate of 8.2%.
• Given the current share price of A$1.18, the analyst price target of A$1.84 is 35.9% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.