Long-Term AI Investment Will Drive Revenue Diversification Despite Transitional Year

Key Takeaways

• Focus on AI capabilities and long-term deals may drive revenue growth, expanding the addressable market and providing earnings stability.
  
• Acquisitions and share buyback program aim to boost operational efficiencies and enhance shareholder value through synergies and increased EPS.
  
• Economic uncertainty and project delays may lead to unpredictable revenue streams and affect Endava's overall profitability and operational efficiency.

Catalysts

Provides technology services in North America, Europe, the United Kingdom, and internationally.

• Endava's focus on AI-enabled capabilities, such as Morpheus and Compass, positions it to leverage the digital shift, potentially expanding its addressable market and driving future revenue growth through AI-driven services.
  
• The company's strategy of securing larger and longer-term deals, particularly in core modernization projects, is expected to contribute to meaningful revenue growth and stability in earnings, despite longer sales cycles.
  
• Endava's acquisition and integration of GalaxE is anticipated to enhance operational efficiencies and support margin improvement, as it realizes cost synergies and operational alignment.
  
• The introduction of a $100 million share buyback program signals a strategic effort to enhance shareholder value, which may boost earnings per share by reducing the number of shares outstanding.
  
• As Endava continues to develop AI applications across various sectors, such as pharmaceuticals, insurance, and automotive, it opens opportunities for new revenue streams and the potential for improved net margins through innovative, high-value solutions.

Endava Future Earnings and Revenue Growth

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Endava's revenue will grow by 2.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from -56.1% today to 0.3% in 3 years time.
• Analysts expect earnings to reach £2.7 million (and earnings per share of £0.07) by about July 2029, up from -£408.3 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting £22.5 million in earnings, and the most bearish expecting £-24.9 million.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 108.0x on those 2029 earnings, up from -0.3x today. This future PE is greater than the current PE for the US IT industry at 18.6x.
• Analysts expect the number of shares outstanding to decline by 3.84% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 13.56%, as per the Simply Wall St company report.

Risks

• The slower sales cycle and elongated ideation to production cycle for AI-led projects could lead to less predictable revenue streams and potentially impact revenue growth if projects take longer to materialize.
  
• The macroeconomic challenges in key regions like the U.K. and Rest of World, as well as reduced spending from clients due to economic uncertainty, could negatively affect Endava's revenue and earnings.
  
• Endava's high reliance on large-scale projects and the slower scaling of these projects may lead to volatility in revenue realization and impact net margins if clients delay commencements.
  
• A decrease in revenue from specific verticals, such as payments and TMT due to client pullbacks, could lead to uneven revenue distribution across sectors and affect overall profitability.
  
• Integration challenges and costs associated with new acquisitions, like GalaxE, may affect operational efficiency and net margins in the short term if synergies do not materialize as planned.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of $5.66 for Endava based on their expectations of its future earnings growth, profit margins and other risk factors.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $10.04, and the most bearish reporting a price target of just $3.5.
• In order for you to agree with the analysts, you'd need to believe that by 2029, revenues will be £790.8 million, earnings will come to £2.7 million, and it would be trading on a PE ratio of 108.0x, assuming you use a discount rate of 13.6%.
• Given the current share price of $2.85, the analyst price target of $5.66 is 49.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.