Cloud Migration Risks And Elongated Sales Cycles Will Pressure Margins Yet Eventually Support Earnings

Catalysts

About Alithya Group

Alithya Group is a digital transformation and consulting firm that delivers high value enterprise application, cloud and AI solutions across North America and select international markets.

What are the underlying business or industry changes driving this perspective?

• Although demand for enterprise wide AI and data centric transformation continues to grow, Alithya remains exposed to elongated sales cycles and phased project awards that may cap the pace of revenue expansion and delay conversion of its growing pipeline into earnings.
• Despite strong momentum in U.S. enterprise application and transformation services, the slower repositioning of Canadian operations away from lower margin government work could create a drag on consolidated growth and limit further gross margin and EBITDA margin gains.
• While cloud migration and modernization projects with partners such as AWS, Microsoft and Oracle should support long term revenue growth, increased reliance on a few hyperscaler ecosystems may intensify pricing pressure and partner driven competition, constraining net margins.
• Although smart shoring and AI driven delivery efficiencies are structurally improving profitability, a still modest 13 percent of the workforce in lower cost centers and rising compensation and integration costs from acquisitions could temper future improvements in operating leverage and earnings.
• While industry adoption of AI agents and sector specific IP, such as health care and manufacturing accelerators, positions Alithya for higher value work, heavy upfront investment requirements and potential client hesitancy to standardize on new solutions may slow revenue ramp and weigh on near term cash flow.

Assumptions

This narrative explores a more pessimistic perspective on Alithya Group compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Alithya Group's revenue will grow by 5.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -5.4% today to 10.0% in 3 years time.
• The bearish analysts expect earnings to reach CA$56.6 million (and earnings per share of CA$0.41) by about December 2028, up from CA$-26.4 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as CA$70.3 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 6.8x on those 2028 earnings, up from -6.3x today. This future PE is lower than the current PE for the CA IT industry at 13.3x.
• The bearish analysts expect the number of shares outstanding to grow by 0.39% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.37%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistently weaker bookings and a book to bill ratio below one, driven by longer sales cycles and large projects being split into shorter phased engagements, could slow organic growth and eventually pressure revenue growth and adjusted EBITDA despite the current pipeline momentum, ultimately weighing on earnings.
• Ongoing repositioning of the Canadian business away from lower margin government work, combined with already declining Canadian revenues and uncertainty around the timing of higher value replacement work, could result in a prolonged revenue drag and underutilization that offsets margin gains, reducing consolidated earnings power.
• Rising SG&A from acquisitions, higher employee compensation and integration related costs, together with higher net debt and a leverage ratio above two times adjusted EBITDA, could limit financial flexibility and erode the benefit of improving gross margins, putting downward pressure on net margins and future earnings.
• Heavy strategic dependence on a few hyperscaler ecosystems such as Oracle, Microsoft and AWS, as well as on specialized AI and cloud transformation projects, exposes the company to partner strategy shifts and competitive pricing pressure, which could compress gross margins and constrain revenue growth if demand patterns change.
• The need for ongoing investment in IP, AI capabilities and smart shore expansion to stay ahead of rapid technological change, while noncash impairments highlight execution and repositioning risks in certain cash generating units, could lead to further write downs or underperforming assets that suppress reported net income and dampen market confidence in long term earnings growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Alithya Group is CA$2.85, which represents up to two standard deviations below the consensus price target of CA$3.34. This valuation is based on what can be assumed as the expectations of Alithya Group's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$4.0, and the most bearish reporting a price target of just CA$2.85.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be CA$567.5 million, earnings will come to CA$56.6 million, and it would be trading on a PE ratio of 6.8x, assuming you use a discount rate of 10.4%.
  
• Given the current share price of CA$1.66, the analyst price target of CA$2.85 is 41.8% 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.