Automation Pressure And Legacy Decline Will Drain Margins

Key Takeaways

• Secular decline in legacy automotive and underinvestment in digital solutions threaten Ricardo's competitive positioning, future revenues, and margin sustainability.
  
• Economic volatility, deglobalization, and STEM talent shortages create further unpredictability, driving up costs and eroding contract stability.
  
• Strategic portfolio shifts, cost efficiency, and focus on high-margin, recurring services position Ricardo for resilient, higher-quality growth across diversified sectors and international markets.

Catalysts

Provides environmental, technical, and strategic consultancy services in the United Kingdom, Europe, North America, China, rest of Asia, Australia, and internationally.

• Rapid advancements in artificial intelligence and automation are likely to reduce the long-term demand for Ricardo's traditional engineering and consulting offerings, compressing its core addressable market and leading to downward pressure on both revenues and margins as projects become increasingly commoditized and clients turn to in-house digital tools.
  
• Growing volatility in global economic conditions, geopolitical fragmentation, and deglobalization trends may further delay or scale back large-scale infrastructure and decarbonization projects, eroding Ricardo's future pipeline and making its recurring multi-year contract revenues far less predictable.
  
• Ricardo's significant exposure to legacy automotive and internal combustion engine segments-now facing a secular decline due to accelerated electric vehicle adoption-risks ongoing revenue contraction and operating income declines, with recent ICE for longer trends only offering a temporary buffer before sharper top-line declines set in.
  
• Persistent underinvestment in digital transformation and proprietary technology could leave Ricardo structurally disadvantaged versus consultants and engineering firms who provide integrated, automation-first digital solutions, pushing client retention lower and limiting the company's ability to sustain margin expansion or premium project fees.
  
• Intensifying talent shortages in STEM disciplines, coupled with rising wage inflation and a shrinking global pool of highly qualified engineers, are set to increase operating expenses and further compress net margins over the long term, making profitable growth increasingly difficult regardless of order book strength.

Ricardo Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Ricardo compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Ricardo's revenue will decrease by 1.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -0.3% today to 2.0% in 3 years time.
• The bearish analysts expect earnings to reach £9.3 million (and earnings per share of £0.15) by about July 2028, up from £-1.2 million today. The analysts are largely in agreement about this estimate.
• 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 19.3x on those 2028 earnings, up from -220.9x today. This future PE is lower than the current PE for the GB Professional Services industry at 22.1x.
• 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 8.02%, as per the Simply Wall St company report.

Ricardo Future Earnings Per Share Growth

Risks

• Despite modest revenue growth in the short term, Ricardo has achieved significant improvement in profitability and operating margin, indicating that ongoing cost management and operational efficiency initiatives could support sustained earnings growth over the long term.
  
• The successful divestment of the Defense business and acquisition of E3 Advisory has shifted Ricardo's profit mix towards higher-margin, recurring revenues from Environmental & Energy Transition services, positioning the company to benefit from secular trends in global decarbonization and infrastructure adaptation and supporting higher net margins.
  
• The company's record order book, especially in Energy & Environment and Rail, demonstrates resilient demand for Ricardo's core services, potentially underpinning future revenue growth even amid macroeconomic uncertainty and delays in project awards.
  
• Strategic diversification from legacy automotive and into higher-growth Industrial, Rail, and Environmental consulting-coupled with investments in digital solutions and proprietary IP-has reduced reliance on cyclical markets and creates opportunities for revenue expansion and gross margin uplift.
  
• Ricardo's deliberate focus on improving operational leverage, recurring digital and advisory revenue streams, and expansion into international growth markets such as Asia and the Middle East could increase both top-line growth and earnings quality over the coming years.

Valuation

• The assumed bearish price target for Ricardo is £2.3, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Ricardo'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 £5.35, and the most bearish reporting a price target of just £2.3.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be £462.0 million, earnings will come to £9.3 million, and it would be trading on a PE ratio of 19.3x, assuming you use a discount rate of 8.0%.
• Given the current share price of £4.26, the bearish analyst price target of £2.3 is 85.2% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• 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.