Digital Adoption And ESG Regulation Will Support This Construction Software Undervaluation Narrative

Catalysts

About Eleco

Eleco provides software for planning, delivering and maintaining projects and assets across the building life cycle.

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

• Rising adoption of digital tools across the built environment, from pen and paper to software based scheduling, estimating and maintenance, positions Eleco’s best of breed, mission critical products to capture a larger share of an addressable market described as over US$8b, which directly supports potential revenue growth.
• The shift toward greener construction, tighter ESG rules and higher safety and compliance requirements, including regulation such as the Safety Act and the future Cyber Resilience Act, increases demand for robust, well documented software stacks, which can support pricing power and help protect net margins.
• Eleco’s model of expanding usage within existing customers through its attain, retain and expand approach, illustrated by multi product relationships like Kingspan and long standing clients adopting newer platforms, creates scope for higher average contract values and deeper ARR per customer, which feeds into recurring revenue and earnings.
• The focus on in house IP with around 80 R&D technicians, rapid product refreshes and use of AI for faster prototyping supports continuous product improvement and stickiness, which can help sustain ARR growth and support EBITDA margins over time.
• Growing demand for asset maintenance and management software in high compliance sectors, combined with the integration of PMAC and ShireSystem and a dedicated marketing and lead generation team, creates a broader SaaS platform in a compliance heavy niche, which is likely to support recurring revenue mix and free cash flow.

Assumptions

This narrative explores a more optimistic perspective on Eleco 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 Eleco's revenue will grow by 19.2% annually over the next 3 years.
• The bullish analysts assume that profit margins will shrink from 10.7% today to 9.9% in 3 years time.
• The bullish analysts expect earnings to reach £5.8 million (and earnings per share of £0.07) by about January 2029, up from £3.7 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 bullish analyst cohort, the company would need to trade at a PE ratio of 46.2x on those 2029 earnings, up from 28.7x today. This future PE is greater than the current PE for the GB Software industry at 32.6x.
• The bullish analysts expect the number of shares outstanding to grow by 0.12% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.72%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The construction and broader built environment sectors are described as challenging, with customers facing complex projects, regulatory change and pressure on their own margins. This could constrain technology budgets and slow the shift from pen and paper to software, limiting Eleco's revenue growth potential.
• Service revenue has already been affected in some geographies and in visualization related lines. If customers continue to trim training and bespoke project spend in favor of bare minimum subscriptions, the mix shift could weigh on total revenue and EBITDA margins even if recurring revenue holds up.
• Growth in the U.S. is starting from a small base and is partly reliant on displacing well established incumbents inside very large contractors. If adoption of Eleco's tools is slower than management expects or confined to small pockets of users, this may cap long term ARR expansion and earnings.
• Eleco's model depends heavily on in house R&D, proprietary code and continual product refreshes powered by a roughly 80 person R&D team. Any difficulty in attracting and retaining specialist talent or misreading customer needs could reduce product competitiveness over time and put recurring revenue and net margins at risk.
• The ARE approach of attaining, retaining and expanding customers relies on cross selling and deepening relationships. Rising bankruptcies among small customers in markets like the U.K. and Sweden and pressure in visualization segments show that parts of the customer base are fragile, which could increase churn and weigh on ARR growth and free cash flow.

Valuation

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

• The assumed bullish price target for Eleco is £2.5, which represents up to two standard deviations above the consensus price target of £2.09. This valuation is based on what can be assumed as the expectations of Eleco'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 £2.5, and the most bearish reporting a price target of just £1.76.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2029, revenues will be £58.4 million, earnings will come to £5.8 million, and it would be trading on a PE ratio of 46.2x, assuming you use a discount rate of 8.7%.
  
• Given the current share price of £1.28, the analyst price target of £2.5 is 48.6% 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.