Appen Limited (APX-AU) 29 August 2017

Transcription

1 Appen Limited (APX-AU) 29 August 2017 Pricing in another Upgrade Marketperform Adam Dellaverde Summary Market capitalisation ($m) $438.7 Share price $ week high $ week low $2.35 Ave Monthly Vol (year rolling) 0.281m Key Statistics (A$ million) Period 1H17 Act. CY17 Est. CY18 Est. Revenue ($m) Adj. EBITDA ($m) Adj. NPAT ($m) Sig items post-tax ($m) Reported NPAT ($m) Adj. EPS(c) Reported EPS(c) DPS (c) Adj. PE Ratio n/m Div Yield n/m 1.8% 2.0% Franking n/m 100.0% 100.0% Payout ratio 34% 45% 45% Market Cap ($m) Net debt/(cash) ($m) (20.0) (22.2) (29.1) EV ($m) EV/Adj. EBITDA (x) EV/Adj. EBIT (x) Share Price Graph (A$) $5.30 $4.30 $3.30 $2.30 $1.30 Our View $4.46 Minor currency headwinds aside, CY17 guidance looks readily achievable, in our view. APX s forward looking metric of revenue plus orders-on-hand has risen from $70m in February to $140m at July end. While this is short of our CY17 revenue estimate of ~$154m, there are five months remaining to close this gap and recent history suggests there is room for positive surprise. Work on hand growth is a great barometer for future business health, in our view. While timing may push revenue from one period to the next, the work-on-hand measure indicates that customers are expanding their programs. Further, APX seems to be succeeding in generating material revenues from new customers and engagements capturing new types of data. EBITDA margins have rebounded following a new pricing structure adopted by a major customer. Management has done an excellent job of reducing variable costs which positions APX strongly for any future price conversations with customers. Importantly, an acceleration of sales growth in Content Relevance is evidence that changes have not compromised performance. 1H profitability was further enhanced by strict control of corporate overhead and new transfer pricing measures which lowered the effective tax rate. We believe we are yet to see full realisation of benefits from cost reduction initiatives and this could provide margin upside in CY18 and/or opportunity to use price opportunistically to further increase market share. Valuation & Recommendation Appen trades on a CY17e PE multiple of 26.0x and an EV/EBITDA multiple of 16.2x. We believe the high trading multiple reflects the potential for another earnings surprise in the 2H. As always, we acknowledge customer concentration as a key risk for APX. Nonetheless, in our view, conditions remain supportive of continuation of strong sales growth, perhaps at moderating but still solid double-digit rates. We value APX at $4.40 applying a multiple of 22x CY18e earnings. Based on our belief that a 2H17 earnings upgrade is already priced in, we think further near term price appreciation requires another exceptional year in CY18. We don t believe this industry offers that kind of forward visibility and for the time being we are comfortable limiting our CY18 EBITDA growth projections at high teen rate. APX-AU XSO-AU We reduce our recommendation to Marketperform based on shares trading at our target price of $4.40.

2 Appen Limited Page 2 of 5 Further Discussion Appen is scaling surprisingly well, with revenue and EBITDA set to double from CY15 levels without a material increase in capital employed. Cash at bank has risen to roughly $20m, which we estimate is be mostly surplus, nonetheless the 1H dividend payout ratio was a paltry 35%. Even with a further $4m earmarked for investment in a new secure data annotation facility there remains substantial free cash on balance sheet earning negligible interest. We get the sense management are keen to deploy surplus cash on M&A, but have yet to find a suitable target. The investment in a new secure data annotation facility builds on the Mendip acquisition in CY16. Management s inference that it could achieve 18 months payback sounds like an excellent deal, and would be consistent with Appen s reputation for being a disciplined capital allocator. We understand the new facility is being pursued based on latent customer demand for certain capabilities, with excellent prospects for utilisation once complete. Should this prove successful, we think it could embolden management to more actively utilise its balance sheet in pursuit of moderately capital intensive opportunities with solid ROI prospects. Language Resources (LR) had quite a strong half for revenue growth although it didn t really come through at the EBITDA line. Some of this was linked to the type of work performed, higher volume but lower margin, and some linked to adverse currency movements. Constant currency revenue was up 17% and EBITDA up 8%. We see Appen as fairly well entrenched as the go-to operator in this space, with customers most motivated by speed to market and performance (not necessarily price). The platform nature of these products and their increasing integration with third party applications reminds us of the software industry where there is a tendency for only one or two platforms to receive critical mass support (think Windows/iOS or Apple/Android app stores). On this basis, we expect Appen s customers to continue to spend aggressively in pursuit of this key platform status, presenting strong prospects for continuing growth for Appen. Content Relevance (CR) margin pressures eased through 1H17 following changes to recruitment practices and improvements in administrative platforms. Management deserve plaudits for the success of these initiatives and the fact they haven t compromised growth, in fact CR growth has accelerated. We suspect the benefit from these initiatives is only part way accrued and lower wage rates for new contractors could lift gross profit margins as the proportion of these contractors increases. Management has indicated they ve had no recent discussions with customers on pricing changes, which suggests Appen could hold on to any margin improvements in the near term. All indicators suggest continuing expansion to existing customer programs, plus new opportunities including the capture of new types of data i.e., image annotation. While we expect the rate of growth in this segment to normalise in CY18, we still expect a continuation of strong double-digit revenue growth.

3 Appen Limited Page 3 of 5 Appen generates the majority of its revenue in USD, so appreciation of the AUD relative to the USD reduces earnings. Last guidance was for 40-50% EBITDA growth based on an exchange rate three cents more favourable. Yesterday s announcement highlighted EBITDA tracking towards the upper end of this range based on a less favourable exchange rate of AUD: USD Currency leverage mainly occurs through the LR business where the majority of support staff are in AUD, and the majority of revenues are in USD. While further AUD appreciation poses a risk for FY17 guidance, we expect realisation of earnings guidance will be most correlated with new revenue capture and timing of revenue recognition for work already on hand. We have made relatively minor adjustments to our numbers as follows: Input of 1H numbers, which beat our estimates by approximately 5%, A 1H17 significant item of $0.572m for intangibles write-off upon activation of new ERP system (old system scrapped). Factoring in the recent appreciation of the AUD:USD Higher intangibles capitalisation for internal software development projects and announced project works for secure data annotation facility, Changes in effective tax rates assumptions based on transfer pricing developments, and A slight moderation of margin improvement expectations for Language Resources.

4 Appen Limited Page 4 of 5 Taylor Collison Research Appen Limited - Summary of Forecasts APX-AU $4.46 PROFIT & LOSS SUMMARY (A$m) BALANCE SHEET SUMMARY P e riod CY 16 A 1H17 A CY 17 E CY 18 E P e riod CY 16 A 1H17 A CY 17 E CY 18 E Total Revenue Cash CODB Receivables Adj. EBITDA Other Dep'n Total Current Assets Amort'n Property Plant & Equip Adj. EBIT Intangibles Net Interest DTA Adj. P re - Ta x Other Tax Expense Total Non- Current Assets Adj. NPAT TOTAL ASSETS Abnormals post- tax Accounts Payable Reported NPAT Borrowings Provisions PER SHARE DATA Other P e riod CY 16 A 1H17 A CY 17 E CY 18 E Total Current Liabilities EPS Reported. (c) Borrowings (0.0) (0.0) Adj.EPS (c ) Provisions Dividend (c) DTL Franking 100.0% 100.0% 100.0% 100.0% Other Dividend Payout Ratio (%) 45.7% 34.2% 45.0% 45.0% Total Non- Current Liab FCF per share (c) TOTAL LIABILITIES Weighted Shrs on Issue TOTAL EQUITY KEY RATIOS CASH FLOW SUMMARY P e riod CY 16 A 1H17 A CY 17 E CY 18 E P e riod CY 16 A 1H17 A CY 17 E CY 18 E Adj. EPS Growth % 19.6% 54.1% 61.6% 12.4% Reported Profit Adj. EBITDA Margin % 15.6% 17.1% 16.9% 16.6% Dep'n & Amort'n Adj. EBIT Margin % 14.7% 16.4% 16.1% 15.3% Decr./(incr.) working capital (0.9) 0.6 (4.0) (5.2) Adj. NPATMargin % 9.4% 10.9% 10.9% 10.7% Decr./(incr.) deferred taxes 1.3 (0.8) Adj. EBITDA Interest cover (x) 2, ,254.3 n/a n/a Icr./(decr.) provisions Adj. EBIT Interest cover (x) 2, ,882.3 n/a n/a Other non- cash/ signif. items (1.6) Net Debt to Adj. EBITDA (x) n/a n/a n/a n/a Gross Cashflows Gearing % (D/D+E) 0.0% 0.0% 0.0% 0.0% Net capex (0.7) (0.6) (4.6) (1.1) Capitalised/purchased intangibles (1.8) (1.6) (2.8) (3.0) SEGMENT REPORTING Acquisitions/(Divestments) P e riod CY 16 A 1H17 A CY 17 E CY 18 E Other investments La ngua ge Re sourc e s Free cash flow Revenue Dividends Paid (4.8) (2.9) (5.8) (8.3) EBITDA Debt issued/ (repaid) 0.0 (0.0) (0.0) (0.0) Revenue growth 18.2% 12.5% 10.0% 10.0% Equity issued/ (buyback) EBITDA Margin 39.4% 36.0% 36.2% 36.5% Net Cash Flow Content Relevance 0.0% Revenue VALUATION MULTIPLES EBITDA P e riod CY 16 A 1H17 A CY 17 E CY 18 E Revenue growth 44.3% 52.4% 54.9% 22.0% PE Ratio (x) EBITDA Margin 14.4% 16.9% 17.0% 17.0% Dividend Yield (%) 1.1% 0.7 % 1.8 % 2.0 % Unallocated (8.1) (3.0) (7.0) (9.2) Adj. EV/EBIT (x) Adj. EBITDA Adj. EV/EBITDA (x)

5 Appen Limited Page 5 of 5 The following Warning, Disclaimer and Disclosure relate to all material presented in this document and should be read before making any investment decision. Disclaimer: Warning (General Advice Only): Past performance is not a reliable indicator of future performance. This report is a private communication to clients and intending clients and is not intended for public circulation or publication or for the use of any third party, without the approval of Taylor Collison Limited ABN ("Taylor Collison"), an Australian Financial Services Licensee and Participant of the ASX Group. TC Corporate Pty Ltd ABN ( TC Corporate ) is a wholly owned subsidiary of Taylor Collison Limited. While the report is based on information from sources that Taylor Collison considers reliable, its accuracy and completeness cannot be guaranteed. This report does not take into account specific investment needs or other considerations, which may be pertinent to individual investors, and for this reason clients should contact Taylor Collison to discuss their individual needs before acting on this report. Those acting upon such information and recommendations without contacting one of our advisors do so entirely at their own risk. This report may contain forward-looking statements". The words "expect", "should", "could", "may", "predict", "plan" and other similar expressions are intended to identify forward-looking statements. Indications of and guidance on, future earnings and financial position and performance are also forward looking statements. Forward-looking statements, opinions and estimates provided in this report are based on assumptions and contingencies which are subject to change without notice, as are statements about market and industry trends, which are based on interpretations of current market conditions. Any opinions, conclusions, forecasts or recommendations are reasonably held at the time of compilation but are subject to change without notice and Taylor Collison assumes no obligation to update this document after it has been issued. Except for any liability which by law cannot be excluded, Taylor Collison, its directors, employees and agents disclaim all liability (whether in negligence or otherwise) for any error, inaccuracy in, or omission from the information contained in this document or any loss or damage suffered by the recipient or any other person directly or indirectly through relying upon the information. Disclosure: Analyst remuneration is not linked to the rating outcome in this research document. Taylor Collison may solicit business from any company mentioned in this report. For the securities discussed in this report, Taylor Collison may make a market and may sell or buy on a principal basis. Taylor Collison, or any individuals preparing this report, may at any time have a position in any securities or options of any of the issuers in this report and holdings may change during the life of this document. Taylor Collison, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. Taylor Collison may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. Accordingly, Taylor Collison s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Analyst Interests: The Analyst presently holds the product referred to in this document, but Taylor Collison Limited considers such holdings not to be sufficiently material to compromise the rating or advice. Analyst holdings may change during the life of this document. Analyst Certification: The Analyst certifies that the views expressed in this document accurately reflect their personal, professional opinion about the financial product to which this document refers. Date Prepared: August 2017 Author: Adam Dellaverde Release Authorised by: Mark Pittman