SINGAPORE (May 20): Despite forecasting a poor 2HFY20 on the back of a bearish Covid-19-hit economy, most analysts have maintained “hold” calls on Silverlake Axis on the back of attractive valuations for the software firm.
How the firm - which specialises in software for the finance industry -- performs going forward, will depend on the willingness of banks and financial institutions to keep up with their IT capital expenditure post-crisis.
“Silverlake Axis reported a weaker 3QFY20, below our estimate. It also guided for a weaker 4Q20, due to the Movement Control Order (MCO) in Malaysia. Large deals continue to be a challenge to close, with many delayed by MCO measures or economic uncertainties,” report RHB analysts Jarrick Seet and Lee Cai Ling.
Seet and Lee have cut their earnings per share estimate for FY20 and FY21 by 6% and 10% respectively on the back of reduced licensing and project service revenue. DBS’s Ling Lee Keng went further, cutting forecasted FY20-21 earnings by 18-19%.
On May 15, the company reported that its core net profit for 3Q20 dropped by 25.7% y-o-y to RM 25.6 million ($8.3 million). Revenue in the same period was relatively flat at RM151.7 million (-2% y-o-y) following weaker-than-expected contribution from project-related revenue segments. This weakness stems from project contract maturity in Thailand and Malaysia, which has led to lower progressive revenue that could be recognised. Nevertheless, new banking implementation contracts in Vietnam and Indonesia in 1H20 and a technology refresh contract in Malaysia in FY19 have offset this.
EBITDA margin and net margin stood at 35.2% and 16.9% respectively for 3QFY20, dragging down nine-month FY20 margins to 43.1% and 24.8% respectively. Similar margin pressures were felt by other enterprise software industry players like SAP and Infosys, arising from falling demand from retail and hospitality arising from Covid-19 and challenges coping with rapid changes in the industry.
“3QFY20 margins were compressed due to unfavourable revenue mix resulting in lower gross profit margin, and higher effective tax rate due to loss of pioneer status by a Malaysian subsidiary,” says Ong Khang Chuen of CGS-CIMB. Operating expenses also rose 16% due to the consolidation of the recently acquired XIT Group and a rise in finance costs. Gross profit margin fell to 54.8% in 3Q20 from 59.0% in 3Q19, driven especially by lower software licensing revenue.
Considering the difficult year ahead, Silverlake’s management has hinted that it would seek to conserve cash and decrease dividends going forward. It also announced a switch from quarterly to semi-annual dividend payouts. Seet and Lee anticipate a 40-50% payout ratio for FY20, and a dividend yield of as low as 2.7% for FY20 - a 1.5% drop y-o-y from June 2019. They have maintained a “neutral” recommendation on the stock in anticipation of weaker earnings ahead.
“The COVID-19 pandemic has greatly impacted the global economy, as well as financial markets. Global air travel has ground to a halt, and cities are under lockdowns. Due to these circumstances, we believe banks will likely pare down costs and raise provisions for defaulting loans. As a result, they will also hold back on major IT spending, and slash IT capex budgets. We think Silverlake will likely face more resistance in securing new projects from the banks or financial institutions,” they comment.
Nevertheless, DBS’ Ling has maintained her “buy” call on Silverlake on the back of attractive valuations. The counter is now trading at a price-to-earning ratio (PE) of 13.5 times for FY20F and 11.8 times for FY21F, near its -1SD (standard deviation) level of its average 4-year forward PE, indicating a more optimistic anticipated dividend yield of 4.5% while acknowledging that Silverlake prefers conserving cash in a crisis.
Kenny Tan of KGI also highlighted Silverlake’s strong order book performance as portents of a stronger 2H20. “Management [reported] no material disruptions and order book cancellations as of date...Given management’s conservativeness over winning large contracts, we think there was a sizable push back of the order book, as management guided for RM 300-350million of contracts to come in after 4QFY20,” he adds.
Demand for Silverlake’s products may also be strengthened as the widespread disruption caused by Covid-19 accelerates three technology megatrends after the pandemic -- digital adoption, cloud migration and artificial intelligence. Tan says that firms will increasingly invest in business transformation going forward, with a survey by market intelligence firm IDC suggesting that this is particularly the case for cloud computing.
Though this trend will divert spending from maintenance IT, Ling expects Silverlake to ride the fintech trend following seven acquisitions over the past decade to broaden its suite of business enterprise solutions. The DBS analyst expects Fintech spending is expected to grow at a CAGR of 4.1% during the 2015-2020 period.
As of 3pm today, Silverlake is trading at $0.24 with a relatively low PE ratio of 8.79. Dividend yield stands at an attractive 7.08%.
