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Sanderson is a well established software and IT service provider in the UK. The company has a proven strong revenue model and a reputable track record of delivering both organic and acquisition-led growth. The Sanderson shares climbed 18% during 2017 and we believe the share price has more room to grow. We find Sanderson well poised in the growing multi-channel retail industry not only with its existing business but also with newly acquired Anisa, which complements the enterprise business of Sanderson and should accelerate new customer attractions.
Key investment points for Sanderson are as below:
Resilient business with strong cash flow: Sanderson owns most of its IPR and over 50% of revenue comes from recurring licence, support and maintenance contracts, which is highly cash generative and provides good earnings visibility.
Established and diversified customer base: The company has around 800 customers following the recent Anisa acquisition with average life span over a decade. Such longstanding partnership with customers is due to the company’s outstanding quality of services and deep customer engagement, which reinforces the customer references. The company rarely loses customers to competitors unless there is a meaningful change in the customers’ business.
Clear strategy and shareholder policy: While the business is subject to macro environments, Sanderson is well positioned in its target markets being retail, manufacturing, wholesale distribution and logistics. The management has a good credential of prioritizing shareholders return by supporting a consistent pay-out ratio of c. 50%.
Background & Outlook
Multi-channel retailers have benefited greatly from the rise of e-commerce and mobile commerce industry. E-commerce retail sales in the UK were £71bn in 2016 and are expected to grow to £113bn by 2021 with digital penetration rate increasing to 25% from 18%, according to eMarketer. As the number of customers shopping across multiple channels increases, the demand for 3rd party logistics and fulfilment as well as the need for a flexible industry-specific software that helps streamlining customer service, shopping experiences, and operations has become crucial. The wholesale industry and general manufacturing sector are also going through fast digitalization due to rapidly changing customer expectations and demands on improved efficiency of supply chain.
According to Allied Market Research, global ERP market is expected to reach c. $42bn by 2020 growing at CAGR of 9% since 2014 propelled by increasing demand for simplifying and integrating complex business interactions across multiple sectors. Among various industry drivers, small and medium enterprises are expected to contribute CAGR of 8% thanks to ERP incentives for SMEs such as low operating costs and inventory reduction.
While the global ERP market is highly fragmented and competition is intensifying, Sanderson benefits from its sector specific focus which often provides competitive advantage. The company has long-standing relationship with UK based SME customers and established its industry know-how by specializing in a number of sectors. In addition, Sanderson differentiates itself from peers by providing specialist vertical solutions and rapid deployment.
Founded in 1983 Sanderson Group is a well-established software and IT service provider primarily to small and medium-sized enterprises in the UK. The group has two divisions: Digital Retail (34% of FY2017 revenue) and Enterprise (Manufacturing 30%, Wholesale Distribution & Logistics 36% of revenue). Digital Retail solutions provide omni-channel technology by bridging the gap between online and instore shopping experience with mobile and ecommerce solutions, in-store technology, and back-office systems. Enterprise provides ERP solutions for general manufacturing, food and drink processing, Wholesale distribution and finally industry-specific software for warehouse management systems. The company has c.50% of revenue recurring from pre-contracted software licence fees and ongoing support services.
Key competitive advantage
Ian Newcombe is a CEO and has over 30 years’ experience in software and IT services. His early career was at ACT Group, Mitsubishi Electric and Talgentra, the latter was part of former Sanderson Group before demerger. Ian was appointed CEO in 2015 and has successfully developed the groups multi-channel strategy. Christopher Winn is the Chairman of Sanderson Group where he joined in 1995 and previously served as CEO. Prior to Sanderson, he worked for British Olivetti until 1974 when he joined the ACT Group, the second UK IT company to be listed on the London Stock Exchange in 1979. Richard Mogg was recently appointed Finance Director in October of 2017 having previously been the COO of Capita’s Education Software division. Richard has extensive M&A experience. The board currently holds combined shares of 23%.
Recent earnings review & outlook
Sanderson posted solid results for FY2017 (ending in September) with revenue up 1% to £21.6m and adj. operating profit up 6% to £3.9m. Gross margin remained high at 82% and the contribution from recurring revenue increased to 52% from 50% in FY2016 suggesting the business remains robust. Sales order intake grew 12% to £13.7m and the order book increased significantly to £5.8m reflecting a large new order from an existing customer to be delivered over two years. A key growth driver was Digital Retail where revenue and adj. operating profit grew 14% and 34% respectively due to a couple of large contracts including Richer Sounds and a leading global fashion brand. As for Enterprise, both revenue and profit declined 4% YoY. The company continued to deliver strong cash generation and ended FY2017 with net cash of £6.2m. With basic EPS increasing 18% YoY to 5.2p, the final dividend increased 11% making a total dividend for FY2017 of 2.65p up 10% from 2.4p for FY2016.
Sanderson is well on track to achieve its 3-year plan (FY15/16 - FY17/18): revenue target of £30m and profit of £4-5m with total accumulated EPS growth over 50%. Along with strong organic growth, the Anisa acquisition should drive further growth in the near term.
Sanderson shares had a nice run of 18% during 2017 and the share price rallied significantly post the announcement of Anisa acquisition in November. The shares are currently trading at 16.1x trailing P/E or 13.6x forward P/E, which is still lower than its peer average of 21x in UK enterprise software market. Both our DCF (assuming 10-year EBIT CAGR of 5%, WACC 8.3%, perpetual growth 2%) and DDM (assuming dividend growth of 10% p.a. for the next 5 years and perpetual growth of 6%) based fair value per share calculation arrives at 104p implying c.24% upside from current share price. Considering the company’s healthy balance sheet and good earnings visibility, current valuation looks attractive in our view.
The management believes macro economic conditions present the most significant risks. A downturn in the economic environment or consumer sentiment can affect digital retail and enterprise software markets as it directly leads to Sanderson’s existing and prospective customers’ IT spending. While the company has not been hit from any Brexit impact, it remains as a concern should it result in further slow down in the UK economy.
Other risks include people and product development and M&A risks. The business largely relies on its own IPR development and skilled people who specialize in respective areas, both of which have a major impact on building and maintaining longstanding customer relationship. As for acquisition, successful integration of selective acquisitions can play a key role in driving growth.
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