downgraded !Event After further analysis and clarifying comments made during Monday's investor day, we felt our short/mid-term estimates as well as consensus were still too high. With lower earnings expectations, our target falls to $39 (from $41).
Q2/F22 EPS (expected Nov. 4) are now forecast to decline 16% to $0.32 ($0.38 previously) vs. $0.45 LY. Consensus is $0.34 (range: $0.32-$0.36), although it seems not all estimates exclude acquisition-related intangible amortization as ours do).
Impact: NEGATIVE
Our earnings revisions are predominantly in the U.S. segment. Labour challenges have actually increased since Q1/F22, with greater pressure from wage hikes, retention/referral/signing bonuses, and overtime. Supply chain conditions also deteriorated sequentially, with third-party services rates down and costs up.
Most supply chain cost increases are expected to be passed through by early-Q3 but, barring improved labour availability, there does not appear to be a near-term solution to the labour issues as we are told it is difficult to raise prices when fill rates are at historically low levels. That said, dairy demand remains strong and the current labour (and supply chain) challenges are both significant and widespread among U.S. companies and, because of this, we would have to believe that industry-wide price increases will become necessary if they persist well into 2022.
To the extent possible, longer-term solutions to the labour shortages are also being accelerated including reducing complexity (fewer SKUs, changeovers), network optimization (shifting capacity to geographies with greater labour availability), and increased automation (as was recently completed in Canada).
TD Investment Conclusion Negative earnings trends could test investors' patience for another ~6-9 months. SAP shares have previously bottomed around 10.5x NTM EBITDA, which would be $28 currently.
This made us question our Buy rating, although we would not expect a trough multiple to be applied to trough earnings for long, if at all, and we still see significant share-price upside over the ensuing few years as earnings growth resumes in Q4/F22. Comps get easier, labour/supply-chain challenges should either subside or be more meaningfully offset with additional price increases, and, mid/ long-term, the Strategic Plan should deliver improved sales and margins.