Slow Software Adoption And Integration Risks Will Challenge Execution Yet Underpin Longer-Term Potential

Catalysts

About Eleco

Eleco provides software for planning, managing and maintaining assets across the building life cycle for customers in the built environment.

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

• Although Eleco’s products support core scheduling and project management needs as construction projects become more complex and time constrained, many customers are still slow to replace manual or fragmented tools. This could limit the pace at which new software wins translate into higher recurring revenue growth.
• While growing interest in digital project control and portfolio management creates a larger opportunity for Asta Vision and related tools, customers often face implementation delays and margin pressure from regulatory change. This may cap the rate at which Eleco can expand average contract values and improve net margins.
• Although the group is positioning its in-house developed code base for upcoming cyber security regulations such as the Cyber Resilience Act, compliance projects can divert R&D and sales resources away from new feature delivery. This could slow the uplift in earnings expected from higher software pricing or premium modules.
• While the acquisition of PMAC broadens Eleco’s maintenance and asset management offering into high compliance sectors, integration of products, sales teams and support functions may take longer than planned. This could delay expected benefits to revenue mix and operating margins.
• Although global clients are beginning to use Eleco’s maintenance and scheduling platforms across more sites and countries, replicating these wins at scale requires sustained investment in go to market and customer success. Any shortfall here could hold back recurring revenue growth and the flow through to earnings.

Assumptions

This narrative explores a more pessimistic perspective on Eleco compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Eleco's revenue will grow by 17.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 10.7% today to 10.3% in 3 years time.
• The bearish analysts expect earnings to reach £5.7 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 bearish analyst cohort, the company would need to trade at a PE ratio of 32.7x on those 2029 earnings, up from 28.1x today. This future PE is about the same as the current PE for the GB Software industry at 32.7x.
• The bearish 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 8.73%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• If construction and maintenance customers continue to rely on pen and paper, spreadsheets and fragmented tools instead of adopting dedicated software, Eleco may capture a smaller share of its over $8b addressable market, which could limit long term revenue growth and recurring revenue expansion.
• The group reports that services revenue has been softer in some geographies and segments, and if customers keep cutting training and implementation budgets, this could slow adoption of higher tier functionality and reduce opportunities to upsell, which may weigh on revenue and EBITDA margins over time.
• Eleco is investing heavily in in house R&D, including upgrading code stacks, UX and AI enabled prototypes, and if these projects fail to translate into commercially successful products or if customer needs shift faster than the product road map, the high R&D spend of about 16% of revenue could pressure earnings and free cash flow.
• The business model depends on high retention and expanding within existing accounts, but the company is already seeing some customer failures and administrations in markets like the U.K. and Sweden, and if insolvencies or down trading accelerate in the construction and interiors sectors, churn could rise and slow ARR growth, affecting revenue visibility and profitability.
• Eleco is pursuing mergers and acquisitions such as PMAC to broaden its asset maintenance offering, and if future deals are mispriced, harder to integrate or fail to deliver the expected cost and revenue synergies, this could dilute margins and constrain cash available for dividends and further earnings growth.

Valuation

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

• The assumed bearish price target for Eleco is £1.76, which represents up to two standard deviations below 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 more bearish 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 bearish analyst cohort, you'd need to believe that by 2029, revenues will be £55.9 million, earnings will come to £5.7 million, and it would be trading on a PE ratio of 32.7x, assuming you use a discount rate of 8.7%.
  
• Given the current share price of £1.26, the analyst price target of £1.76 is 28.4% 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.