SAP: Upgrading Moat to Wide and Raising Fair Value by 76%

Key Morningstar Metrics for SAP

• Fair Value Estimate: $278.00
• Morningstar Rating: ★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

We’ve changed our view on SAP SAP after transferring coverage to a new analyst. The firm is the global market leader in enterprise resource planning software.

The bottom line: After a fresh look, we’ve upgraded SAP’s moat to wide from narrow, raised our fair value estimate to $278 per share from $162, and upgraded our Capital Allocation Rating to Standard from Poor.

• Our previous bearish outlook was based on SAP losing many customers as they reassessed their enterprise resource planning provider when shifting to the cloud. With about 80% of SAP’s legacy on-premises customers now committed to its new ERP (S/4HANA) in some way, we think this risk has been neutralized.
• We think poor capital allocation can be largely attributed to previous management. Current management has done primarily bolt-on acquisitions and focused on an organic turnaround through cloud product development and restructuring, which is now bearing fruit.

Big picture: We think SAP has a wide moat based on switching costs and a return on capital that should rise to the high teens by the end of our forecast period.

• ERP software is a mission-critical component for most firms, as it forms the backbone of core business functions like finance, HR, and production. Considering this and SAP’s primarily large enterprise customer base, we think switching costs are extremely high.

Key stats: We expect low-to-mid-teens revenue growth in the near and mid terms, fading to high single digits in the long term. We expect the adjusted EBIT margin to rise throughout our forecast to the low 30s.

• Revenue growth will be driven by SAP’s core cloud ERP offerings. We expect 25%-plus midterm cloud growth due to the 2-3 times lift in contract value when on-premises ERP customers convert to the cloud and continued success in cross-selling and capturing new midmarket customers.
• Margins should step up in fiscal 2025 due to restructuring and incrementally rise thereafter as the cloud business scales.