Weakening European Economies Drag SAP Shares To 52-week Lows

Shares of German enterprise software major SAP SE (NYSE:SAP) contracted over 5% intra-day before closing down about 2% on October 08, ending the day at $69.21. This is a trailing twelve month low and down 20% from where it began the year.  The latest sell-off in shares of SAP was brought forth by a report from Boerse Online which indicated the company had missed its pipeline targets at quarter-end; other rumors suggested a freeze on hiring from SAP until 2014 end to maintain cost discipline and meet fiscal end targets. ^[1] The source of this fall from grace? Management transitions and the slow adoption of new technologies have inspired investor concerns.

In the six months so far in fiscal year 2014, SAP had managed to grow its revenues by 2% in reported terms to €7.85 billion. Excluding currency fluctuations and on a non-IFRS basis, revenue growth rate in H1FY14 stood at 6%, slower than the 9% registered over a similar period last fiscal year. The  slow adoption of the company’s  cloud-based software deployments, along with a weak macroeconomic environment, has resulted in decelerating sales growth in recent years.

Despite the sluggish top line sales performance, SAP has been able to deliver on its annual earnings guidance by prudent cost management strategies. In H1FY14, operating margins expanded by 40 basis points over H1FY13 to 27.4%. For the upcoming Q3FY14, consensus revenues and earnings per share estimates stand at nearly €4.25 billion and €0.84. On the revenue front, the consensus estimate indicates a year-on-year growth rate of 4.7%. On earnings per share, the consensus estimate represents a year-on-year growth rate of 7.7% for the quarter.

In this article, we take a look at some of the key macroeconomic trends that are expected to influence quarterly results for SAP going forward. We will be reviewing our $96 Trefis price estimate for SAP after the company reports its third quarter results on October 20, 2014.

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Sluggish European Economies to Depress Top Line Growth

Last fiscal year, SAP generated approximately 47% of overall revenues from Europe, the Middle East and Africa (EMEA) region compared to a 31% contribution for Oracle. Germany alone contributes nearly a third in revenues from EMEA for SAP, with remaining revenues being primarily generated in the U.K., France, Switzerland, the Netherlands, Russia and Italy. Revenues from Germany in H1FY14 increased 1% to €1.13 billion from €1.12 billion in H1FY13. The remaining markets within the EMEA region posted a healthy 7.2% growth on a year-on-year basis to reach €2.6 billion in H1FY14.

However, economic indicators are quickly turning sour in the European Union. Most recently, industrial production in Germany shrank 4% in August 2014, the biggest fall since early 2009, compared to consensus estimates of a 1.5% decline. ^[2] The declining factory output numbers have weighed on the German economy, which contracted by 0.2% last quarter despite starting 2014 on a positive note. ^[3]

Likewise, other Western European economies of France and Italy have faltered after showing signs of gaining momentum towards the beginning of the year. On the other hand, conflicts in Eastern European economies of Russia and Ukraine are likely to weigh on SAP’s financial results. Leading indicators from the Organization for Economic Cooperation and Development (OECD) indicate that economic growth within the Eurozone is expected to slow down further over the coming months. ^[4]

As an enterprise software vendor, SAP relies on the performance of other industries for its growth, with companies upgrading software suites in a competitive growth environment. And the gloomy forecasts for Eurozone economies going forward is not helping SAP’s cause at the moment. We expect sales growth in constant currency non-IFRS terms to decelerate further, impacted by the higher exposure to the Eurozone for SAP.

SAP America to Benefit from Depreciating Euro

While the weakening economic environment within SAP’s largest geographic region is likely to impact it adversely, the resulting depreciation of the Euro against the dollar should some thrust to its American subsidiary. In terms of revenues, SAP generated about 38% of sales from the Americas region. SAP’s subsidiary in North America, SAP America, accounted for nearly 28% of overall revenues while the remaining 10% was contributed by Latin American markets. In absolute terms, revenues from North America stood at €4.66 billion in FY13, up 4% from FY12.

An increase of 8% in license and subscription volumes and pricing was offset by a 4% appreciation in the Euro against the U.S. Dollar, resulting in a net 4% growth in sales last fiscal. So far this year, the Euro has depreciated nearly 7.4% against the U.S. Dollar, which should provide good support to growth in volumes and pricing resulting from an expanding U.S. economy. This is because SAP America conducts its daily business in U.S. Dollar terms, and the strengthening U.S. Dollar against the Euro should translate into larger Euro reserves over the fiscal year period. We believe the depreciating Euro should increase the revenue share of the Americas region within SAP’s global geographic portfolio.

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1. SAP Plunges Most Since 2011 After Report on Pipeline, Bloomberg Businessweek, October 2014 [↩]
2. German industrial output dives 4% in August, BBC News, October 2014 [↩]
3. German economy minister: 2014 GDP growth could be less than forecast, Reuters, September 2014 [↩]
4. OECD Leading Indicator Points to Eurozone Slowdown, The Wall Street Journal, October 2014 [↩]