I Missed The Chance To Pick Up SAP Stock Before It Took Off

Introduction

I still have some cash left in my ‘blue chip’ portfolio for a few more high-quality companies, but it’s very difficult to find the ‘no-brainers’ in this market. After seeing how SAP (NYSE:SAP) blasted through the 60 Euro’s on the back of an excellent Q3 report, I was a bit disappointed I didn’t analyze this company before. In this article I take a closer look at SAP’s performance in the first nine months of the current financial year to find out if a purchase of SAP stock is warranted.

Even though this company has a market capitalization of almost $ 100B, it’s really surprising me to see the lack of coverage on Seeking Alpha with just one article in the past seven months. The volume on SAP’s NYSE listing is pretty good and as the American listing additionally has options available, you don’t really have to consider trading in SAP through the German stock exchange as an average daily dollar volume of $ 100M in New York should be sufficient to cover your needs.

Is the 25% share price jump in one month warranted?

In the first nine months of the current financial year, SAP’s revenue increased by 19% to 14.5B EUR $ 16B) mainly due to the integration of the multi-billion dollar acquisition of Concur Technologies into SAP’s corporate structure as well as the effects of a weaker Euro. The operating expenses increased by 25% (mainly caused by a 28% jump in the costs of cloud and software) resulting in a gross profit that was ‘just’ 17% higher and an operating profit of 2.55B ($ 2.8B) EUR, or 1% lower than the corresponding period in the previous financial year.

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Source: Financial Statements

You might not like the slightly lower operating income (as this reduces the operating margin as well, given the higher revenue), but as this difference was caused by R&D expenses as well as increased investments in the sales and marketing division, there might be some benefits from these investments in the future.

What I especially like about SAP is the fact the company’s free cash flow generally is higher than the net income, and that seems to be confirmed in the cash flow statements of the first nine months of the year. The operating cash flow was a very impressive 3.24B EUR ($ 3.6B), a 5% increase compared to the 3.08B EUR ($ 3.4B) in the same period last year.

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Source: Financial Statements

After deducting the 424M EUR ($ 470M) in capital expenditures, the free cash flow was approximately 2.8B EUR ($ 3.1B) but keep in mind the capex will be a bit higher in the fourth quarter of this year, so right now I’m counting on a full year free cash flow of approximately 3.5B EUR ($ 3.85B).

The working capital position is improving and the ‘risk’ is decreasing, but don’t expect a substantially higher dividend.

SAP is working hard to keep its hard-earned cash on the balance sheet and that’s clearly visible on the company’s most recent financial statement. Whereas the working capital position was quite small at just 400M EUR ($ 440M) as of at the end of December 2014, the situation already improved to 1B EUR ($ 1.1B) by the end of the third quarter. Financial flexibility is important, and reducing the net debt as fast as possible should be (and probably is) one of the company’s first priorities.

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Source: Financial Statements

So, a positive free cash flow and a robust balance sheet are two great things, but US-based investors should take into consideration the dividend will very likely be lower than the two previous years. That’s not because SAP will pay a lower amount of dividends, but due to the fact the US Dollar is much stronger than it has been in the past 2 years. Whereas the 2013 dividend of 1 EUR was $ 1.37 per share, this fell by 12% to $ 1.22 over the previous year despite SAP increasing the dividend by 10% to 1.10 EUR.

For the current year, I’m expecting another increase to 1.15 EUR and if the currency exchange rate doesn’t fluctuate anymore, this should translate in a USD dividend of $ 1.27 per share. That’s not bad, but in SAP’s case a weaker US Dollar is better for the shareholders, as a 1.15 EUR dividend and an EUR/USD exchange rate of 1.35 would have resulted in a dividend of US$ 1.55 per share.

Investment thesis

I didn’t have my eyes on the ball and missed the opportunity to pick up shares of SAP at 56-58 EUR ($ 61-63.5 at the current exchange rate) in September. That’s a pity as the company was trading at a forward free cash flow yield of just 6.95% which isn’t much considering SAP is a true household name. It bugs me a little bit, but I have now added SAP to my watch list and the company now is one of the companies I really want to take a position in during a period of market weakness.

SAP is still digesting the $ 8.3B acquisition of Concur Technologies in 2014 but the net debt should be reduced at a rate of 2.5-3B EUR per year and I would expect SAP to start hunting for another acquisition this year as the net debt/EBITDA level is now back to less than 1. Should no decent acquisitions be found, I think the SAP shareholders could look forward to a nice share buyback program.