European Defense Digitalization And AI Adoption Will Drive Powerful Upside Over The Coming Years

Catalysts

About Sopra Steria Group

Sopra Steria Group is a European digital services and solutions provider focused on complex, mission critical IT transformation for public sector, defense, financial services and other regulated industries.

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

• Escalating European defense and sovereignty priorities are driving sustained investment in secure digital infrastructure, where Sopra Steria’s scale and trusted status with ministries, NATO and leading defense primes positions it to capture a growing share of high value projects and structurally lift revenue and operating margins.
• The accelerating need for data protection, cyber resilience and technological independence in Europe is favoring independent, Europe focused providers with sovereign cloud and security capabilities, supporting durable pricing power and higher quality recurring revenue streams that should enhance net margins over time.
• Long term digitalization programs in public sector, transport and healthcare, evidenced by multi year wins with SNCF, NHS and European rail and energy operators, underpin a visible pipeline that can drive a return to top line growth while leveraging existing delivery platforms to support earnings expansion.
• Deep integration in large, multi year frameworks with strategic clients such as Airbus, major European banks and government shared service centers creates embedded positions that should benefit as clients restart and scale postponed initiatives, supporting both revenue growth and improved utilization driven margin gains.
• Rapid industrialization of AI offerings, combined with group wide AI adoption and partnerships with European AI and cloud leaders, is expected to shift Sopra Steria’s mix toward higher value, higher productivity engagements, reinforcing competitive differentiation and driving structurally higher earnings and free cash flow conversion.

Assumptions

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

• The bullish analysts are assuming Sopra Steria Group's revenue will grow by 2.5% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 5.0% today to 6.2% in 3 years time.
• The bullish analysts expect earnings to reach €378.6 million (and earnings per share of €19.61) by about December 2028, up from €282.0 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as €311.3 million.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 16.3x on those 2028 earnings, up from 10.1x today. This future PE is about the same as the current PE for the GB IT industry at 16.3x.
• The bullish analysts expect the number of shares outstanding to decline by 1.28% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.92%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistently weak or only marginally improving demand across key geographies such as France, the U.K. and parts of Europe, following the current organic revenue contraction of 3.8% and guidance that still allows for negative organic growth of up to 2.5% for 2025, could indicate a structurally slower growth profile that limits any sustained acceleration in revenue.
• Difficulty integrating acquisitions and restructuring under challenging market conditions, illustrated by management highlighting a tough Dutch market and a two year integration plan for Ordina alongside simplification and rationalization initiatives, may weigh on utilization and project execution for longer than expected, capping operating margin improvement and earnings growth.
• Higher structural cost pressure from rising social charges in France and the U.K. and ongoing wage inflation, already diluting operating margin on business activity from 9.7% to 9.2% and expected to have a 30 basis point headwind versus 2024, could offset mix and efficiency gains, limiting expansion in net margins and overall earnings.
• Ongoing pressure on working capital and collections, with first half free cash flow at minus EUR 145.9 million and days sales outstanding at 57 days that management aims to bring back to around 50 days, creates execution risk around cash discipline targets of 5% to 7% of revenue and may constrain balance sheet flexibility if collection improvements do not materialize, thereby impacting free cash flow and potentially future shareholder returns.

Valuation

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

• The assumed bullish price target for Sopra Steria Group is €250.0, which represents up to two standard deviations above the consensus price target of €198.4. This valuation is based on what can be assumed as the expectations of Sopra Steria Group's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of €250.0, and the most bearish reporting a price target of just €142.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be €6.1 billion, earnings will come to €378.6 million, and it would be trading on a PE ratio of 16.3x, assuming you use a discount rate of 9.9%.
  
• Given the current share price of €148.6, the analyst price target of €250.0 is 40.6% 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.