AI Integration Will Improve Operational Efficiency And Competitive Edge

Key Takeaways

• Embedded AI in business processes boosts customer adoption, driving revenue and earnings growth through enhanced value creation and a competitive edge.
  
• Simplified licensing and investment in AI improve operational efficiencies, supporting margin expansion and driving faster customer adoption for revenue growth.
  
• SAP faces potential profitability challenges due to macroeconomic headwinds, restructuring risks, slowed cloud transition, tax rate increases, and foreign exchange fluctuations.

Catalysts

Provides applications, technology, and services worldwide.

• SAP's total cloud backlog reached a record high of €63 billion, reflecting a 40% increase over the previous year, indicating potential for strong future revenue growth as these backlogs translate into realized cloud services.
  
• The company has embedded SAP Business AI deeply into business processes, allowing enhanced value creation and a competitive edge, which can improve customer adoption, leading to revenue and earnings growth.
  
• SAP's strategy to increase investments in AI, with a goal to make every Joule user 30% more efficient by 2025, can lead to enhanced operational efficiencies, supporting margin expansion and potentially driving higher net margins.
  
• The company's commercial strategy includes simpler licensing options for RISE and GROW customers to easily upgrade to new solutions, which can facilitate faster customer adoption, thereby driving revenue growth.
  
• Internal AI-driven efficiency initiatives are expected to yield run-rate efficiency effects of around €300 million this year, reducing operational costs and supporting enhanced net margins and earnings.

SAP Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming SAP's revenue will grow by 12.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 9.1% today to 20.1% in 3 years time.
• Analysts expect earnings to reach €9.8 billion (and earnings per share of €8.38) by about March 2028, up from €3.1 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 39.7x on those 2028 earnings, down from 92.7x today. This future PE is greater than the current PE for the US Software industry at 24.7x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.78%, as per the Simply Wall St company report.

SAP Future Earnings Per Share Growth

Risks

• SAP is facing macroeconomic headwinds, and any prolonged economic slowdown could impact cloud adoption and broader business transformation initiatives, potentially affecting future revenue growth.
  
• The ongoing transformation and restructuring efforts within SAP could introduce execution risks, possibly leading to inefficiencies and unexpected costs, thereby impacting operating margins and profits.
  
• The decision to extend maintenance offerings for certain on-premise customers could slow down the transition to cloud solutions, limiting potential cloud revenue acceleration.
  
• The increase in non-IFRS tax rates and restructuring expenses pose risks that could pressure net margins and reduce profitability in the short to medium term.
  
• Foreign exchange fluctuations, particularly if not fully mitigated by hedging strategies, could affect free cash flow and impact earnings given SAP's significant international exposure.

Valuation

• The analysts have a consensus price target of €282.697 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 €48.9 billion, earnings will come to €9.8 billion, and it would be trading on a PE ratio of 39.7x, assuming you use a discount rate of 5.8%.
• Given the current share price of €248.35, the analyst price target of €282.7 is 12.1% 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.