SAP’s Margins Rise With Corporate IT Spending

SAP‘s profit margins have widened lately as its corporate customers extend software maintenance contracts and generally spend more on IT in an improving economy.

SAP (NYSE:SAP) competes mainly with Oracle (NASDAQ:ORCL) and Microsoft (NASDAQ:MSFT) in the enterprise software application market. Following the company’s strong second-quarter earnings report, we have raised the Trefis price estimate for SAP’s stock from $50.12 to $51.94. Our analysis follow below.

ERP and CRM drive the boat

SAP’s two most important software categories are enterprise resource planning (ERP) and customer relationship management (CRM). Together, ERP and CRM software sales constitute more than half of the $52 Trefis price estimate for SAP’s stock.

ERP software helps companies integrate different applications that lack a common interface. If a bank used two different applications to manage its credit card and savings account businesses, for example, reconciliation issues could arise. ERP software is designed to solve such problems.

CRM software helps companies keep track of their customers and understand their requirements. At least in theory, this results in increased customer satisfaction and higher sales.

Fatter margins

SAP’s profit margins on product sales rose from 80% in the first quarter of 2010 to 86% in the second quarter. We expect margins to stay in this range during the Trefis forecast period.  But if ERP and CRM gross margins reach 88% by 2016, there could be a 2% upside to the $52 Trefis price estimate for SAP’s stock.

You can drag the trend-lines in the charts below to create your own ERP and CRM margin estimates for SAP and see how they impact the company’s stock price.

Faster payment

SAP’s “days sales outstanding,” a measure of how long it takes customers to pay their bills, declined from 79 days on December 31, 2009, to 73 days on June 30, 2010, according to the company’s detailed financial report. As a result, SAP has been able to convert sales to cash earlier. From an accounting perspective, this improves the company’s balance sheet by reducing accounts receivable, which in turn reduces net working capital requirements.

We expect a small increase in SAP’s net working capital as a percentage of revenues during the Trefis forecast period, from -1.1% in 2009 to -1.0% by 2016. The next interactive chart shows the impact of this forecast on SAP’s stock price. Drag the trend-line to create your own forecast and resulting stock price estimate.

However, if the company continues to receive faster payments, its net working capital could actually decline. In a scenario where net working capital as a percentage of revenues declines to -10% by 2016, there could be an upside of 5% to the $52 Trefis price estimate for SAP’s stock.

Loyal customers

Many of SAP’s customers have extended their support contracts lately. Software maintenance and support is a good business for SAP, with margins in excess of 90%. Revenues in this segment have risen by nearly 50% this year, from $1.93 billion in the first quarter of 2010 to $2.94 billion in the second quarter. As SAP adds new customers, we expect maintenance and support revenue to grow at an even faster rate.

You can see the complete $52 Trefis Price estimate for SAP’s stock here.