Company Overview: ELMO Software Limited (ASX: ELO) is engaged in providing cloud-based HR, payroll, and expense management solutions. The company was established in 2002 and operates on a Software as a Service (“SaaS”) business model based on recurrent subscription revenues. The company has its offices in Australia, New Zealand, and the UK.

ELO Details

ELO Rides on New Module Adoption & Higher Total Addressable Market: ELMO Software Limited (ASX: ELO) is engaged in providing innovative cloud HR, payroll, and rostering/time and attendance know-how. Recently, the company informed the market that it has unveiled a new module, named Predictive People Analytics. The latest module will enable ELO’s customers to drive advantageous results around employee engagement, insights, and retention. The new module has been developed in collaboration with the University of Technology Sydney (‘UTS’). Additionally, the latest module leverages artificial intelligence and machine learning capabilities to offer insightful data visualisation tools, thus, aiding in people management decisions and detecting high-performing employees who may be a “flight risk”.

The company’s cloud-based platform is engaged in developing and maintaining key growth strategies remotely during the coronavirus-led pandemic. This indicates that the company is well equipped to offer continuous service to its customers. The company remains on track to expand its all-in-one solution, thereby delivering its new and existing customers with the latest modules. These new modules garner further revenue streams and enhance the company’s competitive advantage against its peers.

Module Highlights (Source: Company Reports)

ELO Gains from Acquisition Synergies: The company has built a strong foundation to strengthen its business in the United Kingdom (UK). The Breathe and Webexpenses acquisitions are compelling examples of ELO to expand its market opportunity and propel its growth strategy. Both businesses are UK-based. The Breathe’s buyout in the UK is an essential milestone in ELO’s development. Breathe will be introduced into the Australian market in the second half of FY21, thus leveraging ELO’s infrastructure and expertise. Notably, Breathe’s scalable platforms increase ELMO’s Total Addressable Market (TAM) by A$2.2 billion and provide a deeper footprint in the United Kingdom, Australia, and New Zealand. The company’s total mid-market TAM stood at $10.6 billion. Post the acquisition of Breathe, ELO’s TAM amounted to ~$12.8 billion. Whereas the acquisition of Webexpenses provided a robust operational and mid-market customer base in the same region, thus, enhancing its technology know-how, and increasing its customer base in the UK.

ELMO Group Total Addressable Market (Source: Company Reports)

ELO Gains from Mid-Market Expansion: In 1HFY21, the company’s mid-market business continued to grow sharply by 95.7% year over year to 2,892 customers. Mid-market annualised recurring revenue increased by 29.5% from the prior corresponding period and came in at $67.3 million. The mid-market gross profit margin also improved from 84.6% reported in 1HFY20 to 88.5% in 1HFY21. As at 31 December 2020, new customers purchased an average of 4.0 modules. Coming to the small business segment, Breathe increased its customer base to 7,146 as at 31 December 2020. ELO remains well-positioned to fund its growth initiatives. Group headcount as at 31 December 2020 stood at 524.

Group Headcount (Source: Company Reports)

1HFY21 Sneak Peak: In 1HFY21, the company’s record annualised recurring revenue soared 42.8% on a year over year basis and came in at $74.2 million. Of this, more than 97% of the revenue was subscription-based. The company continues its scale of operations with an enhanced focus on research and development. These initiatives are likely to position ELO as a leading cloud, Software-as-a-Service, HR, and payroll provider in Australia and New Zealand. In addition to the robust financial performance, the company also invested significantly during the period to enhance its technological capabilities, sales & marketing resources, and expansion of product suite to promote long-term, sustainable growth for the business. Moreover, the company remains committed to invest in research and development with the total spend amounting to 46.5% of statutory revenue in 1HFY21 as compared to 44.9% in 1HFY20. The period also saw record cash receipts, amounting to $34.4 million, up 25.5% on year over year basis. Capital raising is likely to help the company to achieve its goal and organic growth initiatives.

Cash Receipts Highlights (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders together form around 59.27% of the total shareholdings, while the top 4 constitutes the maximum holding. Jlab Investments (No. 2) Pty. Ltd. is the entity, holding maximum shares in the company at 15.31%. Immersion Capital Master Fund Ltd. is the second-largest shareholder, with a holding of 14.98%, as also highlighted in the chart below: 

Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group  

Key Metrics, Healthy Balance Sheet and Decent Liquidity: For 1HFY21, the company reported a gross margin of 85.4%, higher than the industry median of 79.7%. In 1HFY21, the company’s cash cycle days stood at 59.6 days as compared to 1HFY20 cash cycle days of 71.3. The company has also built a decent balance sheet position with total assets reaching $290.7 million as at 31 December 2020, up from $164.9 million as at 31 December 2019. ELO has cash and cash equivalents and total debt at the end of the period amounted to $71.3 million and ~18.7 million, respectively.  Net cash from operating activities came in at $2.99 million for the period ended 31 December 2020. The company’s healthy balance sheet and skilled management team along with its long-term nature of customer relationships place it for considerable long-term growth.

Growth Profile and Profitability Metrics (Source: Refinitiv, Thomson Reuters), Analysis by Kalkine Group  

Risk Analysis: The company’s net loss after tax in 1HFY21 came in at $12.4 million, higher than the year-ago loss of $8.5 million and 2HFY20 loss of $10.11 million. These mounting expenses may throw tough challenges at the company’s overall functioning and may dampen margins, going forward. ELO continues to acquire a large number of companies, which add to integration risks. It can also adversely impact its balance sheet. Moreover, stiff competition in the markets where ELO operates, COVID-19 led disruptions, and regulatory concerns may dampen financial performance. Further, foreign currency fluctuation risks and government restrictions add to the woes. The company is exposed to credit risk, liquidity risk and market risk, arising from financial assets and liabilities.

Outlook: The company remains on track to witness growth momentum across the business. Looking at the present global scenario, it seems that the coronavirus pandemic has begun a new era of work from home. Thanks to the development in cloud-based business solutions, artificial intelligence, quick digitalisation and internet security, millions of employees are remotely working for months now. Given this scenario, ELO’s mission-critical cloud solutions capitalise on this shift to virtual living. Furthermore, the company remains on track to implement its long-term growth strategy, owing to higher adoption of cloud-based technology, enhance customer numbers, increase platform usage, and geographical expansion. ELO expects a decent growth in ARR and revenue in FY21. ELO now expects its FY21 ARR to be in the range of $83 million and $85 million (previously $81.5 million and $88.5 million). Further, the company now expects FY21 revenue to be between $68 million and $70 million (previously $65 million and $71 million).

FY21 Guidance (Source: Company Reports) 

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group 

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks. 

Stock Recommendation: Over the last three months, the stock went down by ~19.8%. The stock made a 52-week low and high of $4.55 and $7.86, respectively, and is currently trading below the average of its 52-week trading range. We have valued the stock using an EV/Sales multiple based illustrative relative valuation method and arrived at a target price of an upside of low double-digit (in percentage terms). We believe that the company might trade at a slight premium to its peer average, considering decent top-line performance, heathy balance sheet, high customer retention rates, focus on delivering organic growth, and encouraging outlook. We have taken peers like Nearmap Ltd (ASX: NEA), Nitro Software Ltd (ASX: NTO), to name a few. Considering the above-mentioned factors, decent 1HFY21 new module adoption, financial performance, synergies from strategic acquisitions, increasing gross margins, and positive long-term outlook, we give a “Buy” recommendation on the stock at the current market price of $4.72, up by 0.425% on 21 May 2021.  

ELO Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

Note: Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.

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