Rebuilding Growth: Challenges and Opportunities for Fabrity in Q2 and Beyond
GPW’s Analytical Coverage Support Programme 3.0 05.06.2023 11:59
A good start to the year, challenging base in Q2 After a strong first quarter, we raise our price target by PLN 3 per share to PLN 38, but we reiterate a Hold rating.
The excellent results of Fabrity, which reported over 30% growth in operating revenues and a similarly strong increase in operating profit, improve our perception of the company compared to other representatives of the software house segment listed on the Warsaw Stock Exchange, where the organic growth rate is slowing down and pressure on margins is visible.
We approach the second quarter with a bit more caution, taking into account last year's demanding base for Fabrity (Q2 was the most profitable quarter for the company in 2022) and less favorable exchange rates, with the strengthening of the PLN, which naturally affects the profitability of revenues from foreign markets in the short term.
We believe that it will be harder to improve the result in Q2, but we hope for a return to higher dynamics in the second half of the year. Fabrity's customers are in many cases less dependent on economic fluctuations. Apart from Frontex, many contracts are projects with a horizon of several years, which should offset the impact of the slowdown in the sector on the company's results. At the same time, it has become easier to recruit employees. Fabrity increased the team by nearly 30 people in the first quarter, compared to 220 at the end of 2022.
The proposed PLN 4.0 per-share payment is slightly higher than the PLN 3.2 mentioned by the Management Board at the previous conference as the lower limit of the range resulting from the dividend policy. The amount is close to the net cash the company had at the end of Q1'23 and together with the PLN 8.4 per share paid in the previous year, it probably ends the period of above-average distribution, at least until (if) the marketing business is sold.
PerfectBot will use the potential of GPT models
Currently, the company is rebuilding the product to use the full potential of GPT models, and in the second quarter it plans to increase the number of US customers testing PerfectBot GPT (a dozen or so entities). Commencement of commercialization is planned for 3Q23.
We present restated annual results for the years 2021-22 and in the forecast period with the marketing segment in discontinued operations, which means that practically only the Fabrity business affects revenues and operating results. We assume that it will be more difficult to attract new customers this year due to the weakness of the entire market and, consequently, we expect revenue growth to slow down from +26% y/y in 2023 to +16% in 2024, with a similar operating margin.
Dividend payment in Q4 will reduce financial income in subsequent quarters, which will result in a lower than EBIT increase in net profit in 2023. Below EBIT, we assume a positive contribution from the marketing segment of PLN 1.9m in 2023 and PLN 1.8m in 2024, minority interest profits in Fabrity (PLN 1.1 million and PLN 1.3 million, respectively) and a loss of approximately PLN 0.5 million annually attributed to the 50% stake in PerfectBot
Our target price is based on DCF (PLN 36.3) and total-of-the-parts (PLN 39.2) valuations. In the sum-of-the-parts valuation, we rely on the Polish peer group for Fabrity, the valuation from the last financing round less a 10% discount for PerfectBot, and target EV/EBITDA and EV/EBIT ratios for marketing.
Valuation Valuation Approach
After moving the results of marketing to discontinued operations in our forecasts, we change the weights of individual valuation methods in the calculation of the target price. We no longer take into account the comparative valuation, where 50% weighting were foreign companies from the marketing sector.
Our target price is now based on the DCF valuation (PLN 36.3) and the total-of-the-parts valuation (PLN 39.2, including the Polish peer group for Fabrity, the valuation from the last financing round less a 10% discount for PerfectBot and EV/EBITDA and EV/EBIT ratios for marketing). In the sum-of-the-parts method, the Fabrity valuation range is set by comparison to a wider IT group (lower end) and only to two representatives of the software house sector (upper end).
DCF valuation DCF valuation assumptions:
1) Risk-free rate at 6.0% in the detailed forecast period (previously 6.5%), and 5.0% on TV (unchanged);
2) 7.5% market premium (according to our methodology for entities below sWIG80);
3) Beta unleveraged 1.0x, residual growth rate 3.0% (previously 2.5%, we are increasing after excluding the marketing segment)
• Risk related to increased competition in the software house segment
• General economic situation
• Risk of losing customers
• Risk of losing key employees
• The risk of failure of the PerfectBot project
• Risk related to customers' failure to meet payment deadlines
• Currency risk (most of Fabrity revenues is denominated in foreign currencies)
The abovementioned risk factors were covered in detail in the initiation report.