Sygnity - Analytical report: FY2022/23 EBITDA Forecast-(WSE:SGN)
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This analysis was prepared by mBank at the request of the WSE as part of the Exchange's Analytical Coverage Support Programme
Sygnity: sell (reiterated)
SGN PW; SGN.WA | IT, Poland
Overvalued With Weak Growth Prospects
Shares in Sygnity plummeted 20% over the past month, underperforming the broad market index by 14pp, but we nevertheless maintain our bearish call on the Company after updating our models to include earnings results for the nine months ended 30 June 2022 (9M’21/22).
Sales at Sygnity have been on a consistent upward trend for several quarters, and in the third quarter of fiscal FY2021/22 (calendar Q2 2022) they showed a marked acceleration.
At the same time, there is persistent upward pressure on salaries in the tech industry as a whole, with a 10% increase or more forecast in 2022, that leads us to expect a slight profit decline at Sygnity in the coming quarters.
With all this in mind, we have cut FY2022/23 EBITDA forecast for Sygnity by 7% to PLN 42.0m, and we have revised the expected net profit 4.1% lower to PLN 25.4m. On the updated estimates, SGN stock is trading at implied EV/EBITDA and P/E ratios of 9.4x and 16.1x, respectively, showing respective premiums of 16% and 31% relative to the median peer ratios, and far outpricing the multiples of Asseco Poland and Comarch – two much better alternatives at the current levels given their size and liquidity.
After also updating our models to assume a market risk premium of 6.00% and updated risk-free rate assumptions, we lower our target price for Sygnity to PLN 13.30, implying 27% downside potential and a sell recommendation.
Good FY2022/22 Q3 Results
Sygnity delivered the first major revenue increase in a long time in the third quarter of fiscal FY2021/22; in the two previous quarters, year-on-year topline growth was constrained at 2-4%. At the same time, sales margins continued to weaken in Q3 while SG&A expenses increased, resulting in substantial contraction in quarterly profits. Sygnity is not able to grow revenues fast enough to offset rising costs.
Pay Pressures Expected to Weigh
Payroll accounts for a major part of Sygnity's operating expenses. In 2021, the average salary offered in the Polish tech industry remained on an upward trajectory despite the coronavirus pandemic, with the average salary rising in the high single digits as selected specialists received 10% more on average in pay than in 2020. Sygnity has to offer competitive salaries if it wants to attract top talent and skilled specialists for its teams.
Increasing Exposure to Government Contracts
The public sector accounted for 41% of Sygnity’s revenue in H1 FY’2021/22, and it has been responsible for a large part of this year’s revenue growth. Since then, the Company has added several big orders from the Ministry of Finance – a bad strategy in our view given its poor track record with government contracts in the past; we would rather see Sygnity reduce its exposure to the public sector.
Key Risks
Goodwill Impairment
Sygnity recorded goodwill in the amount of PLN 157.2m as of 30 June 2022, representing more than half of the balance sheet total. A deterioration in the Company's financial standing could lead to impairment of that goodwill which in turn could lead to a violation of debt covenants.
No Dividends
Sygnity’s net debt is relatively low, with the IFRS 16 ending FY2021/22 balance expected to approximate PLN 8m, equivalent to 0.2x adjusted EBITDA. At the same time, however, the Company has a relatively small asset base after several years of curbed capital expenditures.
If Sygnity increases investment and expenses on customer acquisition, this could result in negative changes in working capital, leading to curbed medium-term dividend payments despite good cash flow generation.
Supplier Risk
Sygnity serves as a local partner to global technology companies, integrating their solutions into customer systems and providing a range of services from training, to maintenance, upgrades, and extensions. If global software providers were to change the terms of their partner policies, for example by limiting the number of local partners or by bringing implementation services in different markets in house, this could have a negative effect on revenues.
Increase in Labor Costs
Payroll accounts for a major part of Sygnity's operating expenses. The average salary offered in the Polish IT industry has been on a steady rise for the last several years, rising in the high single digits in 2021 as the monthly earnings of selected specialists increased more than 10% compared to 2020. Sygnity has to offer competitive salaries if it wants to attract top talent and skilled specialists for its teams.
Liquidated Damages
Sygnity is always at risk of claims under liquidated damages- and warranty clauses contained in its many contracts with customers and business partners. As of 30 June 2022, the Company reported having conditional off-balance-sheet obligations under performance and warranty clauses in the amount of PLN 13.2m.
Public Contracts
Sygnity competes in government tenders for IT services which are typically awarded to the lowest bidder. Meanwhile, the biggest contracts usually require the onboarding of subcontractors, which heightens the risk of default. Another risk are cost overruns on underestimated projects (Sygnity's 2013 e-Taxes contract is one example of an underrated budget).
Long-Term Contracts
The pricing and successful delivery a long-term contract hinges on many factors, some of which are beyond the control of the supplier. For example, the actual figures at the end of the contract might miss the initial revenue, cost, and profit targets, leading to provisions, adjustments and write-offs (cost overruns are the most common issue), and in the worst case to events of default.
Exchange Rate Risk
Sygnity's revenues and costs are affected by changes in the zloty's exchange rates relative to the euro and the US dollar. On the balance sheet, assets and liabilities denominated in foreign currencies consist exclusively of trade receivables and trade payables.
Corruption Probe
In 2019, Sygnity became involved in an investigation into allegations of corruption in the award of contracts by the Polish Post Office brought against its employees, including the CEO and the Supervisory Board Chairman. The Company cooperated with the authorities and turned over all requested records and items. Since we do not have knowledge about the current status of the case, we cannot tell whether or not it might affect the Company's business in the future.
Valuation
Using DCF analysis and relative valuation, we set our ninemonth per-share price target for Sygnity at PLN 13.30.
Multiples Comparison
We compared Sygnity with its peer group based on forward P/E and EV/EBITDA multiples, each with an equal weight in the valuation outcome. Each of the forecast years, calendar 2022, 2023, and 2024, is assigned an equal weight. For Sygnity, we took fiscal years of FY2021/22, 2022/23, and 2023/24 as corresponding to the calendar years. We applied a 15% discount to the valuation outcome to reflect Sygnity’s slower earnings growth. Our model takes into account the NPV of a deferred tax asset arising from prior years’ losses.
DCF Valuation
Assumptions: â–ª The forecast period spans the fiscal years of FY2021/22 – 2030/31. â–ª The perpetuity risk-free rate is 4.50%. â–ª We assume FCF after the forecast period will grow at a rate of 2.0%. â–ª Net debt is ex IFRS 16 as of 30 September 2021. â–ª Perpetuity D&A expenses and CAPEX are assumed to be equal.
Financial Results for Q3 FY2021/22
Sygnity missed our estimates with its financial results for the three months ended 30 June 2022 (Q3 of FY2021/22).
Revenue amounted to PLN 54.4% in the period after an 8.9% rebound from the same period a year earlier. The gross margin posted a year-over-year decrease of 1.6pp at 30.5%. SG&A expenses increased to PLN 10.2m from PLN 8.1m a year ago. Other operating activity provided a PLN 0.2m gain.
After all this, EBIT came in at PLN 6.5m in Q3’21/22 and EBITDA amounted to PLN 9.2m, a year-over-year fall of nearly 17%.
Financing activity was neutral to the quarterly results, and the effective tax rate was 16.9%, resulting in net profit of PLN 5.4m.
Sygnity delivered the first major revenue increase in a long time in Q3 FY2021/22; in the two previous quarters, year-onyear topline growth was constrained to 2-4%.
At the same time, sales margins continued to weaken while SG&A expenses increased, resulting in substantial contraction in quarterly profits.
Sygnity is not able to grow revenues fast enough to offset rising costs.
Future Prospects
Sygnity did not disclose the current size of its order backlog at the Q3'21/22 earnings conference.
Nonetheless, we do see a pickup in revenue momentum, backed by new large contacts added in the last few months. They include:
(1) A 24-month systems support framework agreement with the Information Technology Center of the Finance Ministry, with a maximum value of PLN 99m gross, and
(2) Another framework with the Ministry regarding outsourcing of specialists over a period of 36 months, with a total maximum value of PLN 77.2m gross.
We have raised our revenue forecasts for Sygnity after factoring the new contracts into our models.
At the same time, to reflect the fact that the salaries of the Company's tech personnel, which account for a major portion of annual costs, are estimated to increase more than 10% a year, we assume as a baseline scenario that Sygnity's future sales margins will be narrowing.
As for EBITDA margins, they could be in the 14.5-15% range assuming a reasonable approach to SG&A expenses.
Our EBITDA forecasts for Sygnity for FY2021/22 and FY2022/23 have been revised downwards.
Analyst: Paweł Szpigiel +48 22 438 24 06 pawel.szpigiel@mbank.pl
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