Digitalisation And Regulatory Demands Will Drive Long-Term Upside Potential

Catalysts

About Eleco

Eleco provides mission-critical software solutions that support planning, delivery and maintenance across the building life cycle for the global built environment.

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

• Ongoing digitalisation of construction and maintenance workflows, moving customers from pen and paper and spreadsheets to specialist software, is expected to support double digit subscription growth and expand recurring revenue and ARR.
• Heightened regulatory focus on building safety, cyber resilience and compliance, including the Cyber Resilience Act and post Grenfell safety rules, increases demand for robust, well documented in-house code bases, which in turn supports pricing power and net margins.
• Customers are consolidating vendors and standardising on fewer, stickier platforms that span the building life cycle, which may deepen wallet share per account and enhance revenue visibility and earnings quality.
• Integration of PMAC with ShireSystem and the build out of a dedicated asset maintenance go to market team are creating a more scalable, higher value maintenance platform, improving cross sell opportunities, international expansion potential and group EBITDA margins.
• Scaling in large markets such as the U.S. and new high compliance verticals like pharmaceuticals and FDA regulated manufacturers provides a long runway to grow direct customer relationships, potentially supporting sustained revenue growth and operating leverage.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Eleco's revenue will grow by 15.5% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 10.7% today to 9.5% in 3 years time.
• Analysts expect earnings to reach £5.1 million (and earnings per share of £0.06) by about December 2028, up from £3.7 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 43.8x on those 2028 earnings, up from 29.8x today. This future PE is greater than the current PE for the GB Software industry at 33.3x.
• 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 8.74%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Prolonged weakness or further deterioration in construction and fit out activity, especially in key markets like Germany and the U.K. where management already highlights budget constraints and project delays, could slow customers’ digital transformation journeys and dampen new software adoption, weighing on revenue growth and operating leverage.
• If service and training revenues continue to decline as customers cut discretionary spend or postpone implementation projects, Eleco may struggle to fully monetize its installed base and slow the pace at which customers progress to higher value, insight led use cases. This could limit expansion of recurring revenue and constrain EBITDA margin improvement.
• A rise in bankruptcies among smaller contractors and trades, as already seen in Sweden and the U.K., could accelerate in a tougher macro environment. This may offset wins with new, lower maturity customers and erode the net customer base, which would pressure ARR growth and ultimately earnings.
• Execution risk in international expansion, particularly in the U.S. where Eleco is still building brand recognition against entrenched incumbents, may mean that the large addressable market does not translate into the assumed pace of penetration. This could keep revenue and profit margins below expectations for several years.

Valuation

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

• The analysts have a consensus price target of £2.09 for Eleco 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 £2.5, and the most bearish reporting a price target of just £1.76.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be £53.2 million, earnings will come to £5.1 million, and it would be trading on a PE ratio of 43.8x, assuming you use a discount rate of 8.7%.
  
• Given the current share price of £1.33, the analyst price target of £2.09 is 36.0% 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.