Cloud And AI Tools Will Drive Future Transformation

Key Takeaways

• SAP's cloud growth and investment in AI and data solutions position it for long-term revenue and margin expansion despite global uncertainties.
  
• Strong execution on transformation initiatives improves cloud margins and operating profits, indicating potential for sustained earnings growth.
  
• SAP faces potential revenue impact from trade disputes, cloud revenue deceleration, complex transactions, partnership pressures, and exchange rate risks.

Catalysts

Provides enterprise application and business solutions worldwide.

• SAP's current cloud backlog expanded by 29% in Q1 to €18.2 billion, and cloud revenue is expected to reach near €5 billion with a 26% increase. The high recurring revenue share, which is now at 86%, sets the foundation for potential double-digit revenue growth in 2025 and beyond.
  
• SAP's investment in business transformation tools like SAP Business Data Cloud, which unifies and governs data across platforms, could drive incremental revenue by increasing demand for data-centric and AI-powered solutions. This may also positively impact margins due to high potential value from data products and semantic layers.
  
• The successful execution of SAP's transformation program is recognized by a 2.6 percentage point improvement in cloud gross margins to 75%. Operating profit is up 58% compared to the previous year, suggesting strong potential for future net margin and earnings growth.
  
• SAP aims to maintain a highly resilient business model, supported by its strong market position and a diversified product suite amid global uncertainties. This positions the company for stable or increased revenue, even in volatile environments, by providing solutions that are relevant for compliance and adapting to new regulations and tariffs.
  
• The continued focus on AI adoption, with key offerings like Joule for Consultants and Business AI, positions SAP to drive productivity and efficiency improvements both internally and for its customers. This is likely to enhance net margins and support long-term earnings growth, as increased productivity can allow for cost savings and improved output.

SAP Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming SAP's revenue will grow by 12.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 16.3% today to 20.4% in 3 years time.
• Analysts expect earnings to reach €10.2 billion (and earnings per share of €8.63) by about April 2028, up from €5.7 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as €7.9 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 38.0x on those 2028 earnings, down from 49.2x today. This future PE is greater than the current PE for the US Software industry at 26.3x.
• Analysts expect the number of shares outstanding to grow by 0.35% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.93%, as per the Simply Wall St company report.

SAP Future Earnings Per Share Growth

Risks

• Uncertainty in global trade dynamics and potential trade disputes could negatively impact SAP's ability to convert pipeline deals, potentially affecting future revenue growth.
  
• While the cloud backlog is strong, the deceleration of transactional cloud revenues due to macroeconomic conditions could impact SAP's overall cloud revenue and, consequently, its net earnings.
  
• The complexities and potential delays in ramping up cloud deals, as seen with back-end-loaded transactions, could create short-term fluctuations in expected revenue streams.
  
• SAP's reliance on partnerships for innovations like the Business Data Cloud, particularly with companies like Databricks, may introduce margin pressures if the underlying agreements are not consistently favorable.
  
• The impact of exchange rate fluctuations, especially with a weaker dollar, poses a risk to SAP's revenues and operating profits if not adequately hedged or anticipated.

Valuation

• The analysts have a consensus price target of €275.428 for SAP 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 €320.0, and the most bearish reporting a price target of just €158.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be €49.8 billion, earnings will come to €10.2 billion, and it would be trading on a PE ratio of 38.0x, assuming you use a discount rate of 5.9%.
  
• Given the current share price of €241.7, the analyst price target of €275.43 is 12.2% 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.