Systems, Applications & Products in Data Processing (SAP SE) is a German multinational software corporation that makes enterprise software to manage business operations and customer relations.

We started coverage of SAP with a Buy recommendation and a price target of €133. We like the Company because we expect to see continuous improvement in margins in the years ahead at a very strong pace. Management reported an EBIT margin of 28.96% in 2018 and is expecting it to increase by more than 34% by 2023.

The increase in margins will come from three primary factors;

· Strong sales momentum for cloud subscription focusing on the help of SAP's partnerships with AWS, Microsoft Azure and Google in the public Cloud infrastructure market rather than on the private cloud

· A reduction in advertising expenditure

· Greater resilience of new license sales (licenses are very profitable and generally carry a 70%+ gross margin)

We see current weakness in the shares post Q2 2019 results as an opportunity to open a new position in the stock. The disappointment was amplified by elevated expectations – particularly around the operating margin – where expectations had risen after the very strong Q1 results. Nonetheless, management left their full year targets (as well as mid-term targets) unchanged.

We are also of the view that SAP is well positioned to benefit from any positive outcome of the trade war between the US and China. In fact, the weakness in Q2 was due to Software licenses, which saw a decline mainly because of weak demand from Asia due to macro and trade-related uncertainties.

We are cautiously optimistic about the outlook of the Group and recommend investing in the stock to take advantage of its price weakness.

Risks

· Increased competition

· Lower rate of growth in demand for cloud and cloud services

· Higher expenditure than expected

· Increased tensions between US and China

· Global recession

Dividends

For FY 2018 SAP returned a dividend of €1.50 per share to shareholders, a 7% increase over FY 2017 dividend.

H1 2019 results summary

· Net sales of € 2,568 million, net systems sales of € 1,851 million, Installed Base Management sales of € 717 million

· Gross margin of 43.0%

· Operating margin of 19.2%

· Net income as a percentage of net sales of 18.5%

· Net bookings of € 2,828 million, including 10 EUV systems

Conclusion

We are comfortable holding SAP in a well-diversified portfolio. It is well positioned to continue to benefit as the demand for cloud continues to increase.

SAP has a strong set of financial statements and we expect the company to continue strengthening its position in years ahead.

This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, https://cc.com.mt/ . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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