Endava: Margins under pressure, but outlook is good (NYSE: DAVA)

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Investment thesis

Shares of Endava plc (NYSE:DAVA) have corrected 27% from their December highs as interest in growth companies has waned in the market. In our view, this is an excellent opportunity to take a stand. Endava is actively growing in the most competitive market – North America. Endava can grow more than twice the current North American market revenue by 2026 if it achieves the same market share as in Europe. Given current growth rates and the acquisitions of Levvel and FIVE – it’s quite likely. DAVA has strengthened its position in the huge and promising American banking sector through strategic acquisitions. Although margins may be under pressure in the short term due to inflation, in the long term the business will become more profitable as revenue per employee steadily increases. It is important that DAVA grow organically at double digit rates. According to our assessment, the company is trading at a discount to a fair price. We value stocks as a To buy.

Key risk

The ten largest customers account for 35% of the company’s total turnover. High concentration creates significant risks for shareholders, since the loss of one or more key customers can significantly affect the expected dynamics of financial indicators. However, we do not consider this risk in the DCF model, as Endava regularly reduces the degree of concentration due to the influx of new customers.

Company Profile

Endava plc is a software developer that provides process and production automation services, digitization consultancy and connectivity to cloud technology. The Company operates in three segments:

  • Financial Services and Payments serves capital markets businesses, including insurance, banking, and payment companies;
  • The TMT segment serves media and telecommunications companies;
  • Other includes companies in the healthcare, retail and logistics sectors.

The revenue structure is shown below:

Revenue structure

Created by author

Endava plc is based in London and operates primarily in the UK (41.9%), North America (31.4%) and Europe (24.2%). However, employees are located in Moldova, Croatia, Bosnia and Herzegovina, Argentina, Mexico, etc. Endava is a people business and salaries make up most of the company’s expenses. Thus, DAVA earns in hard currencies (USD, EURO and GBP), and at the same time pays lower wages than in the United States, Great Britain or Western European countries.

Acquisitions and focus on North America

In 2020-2021, Endava announced the acquisition of three companies: CDS, Five and Levvel. The acquisition of Comtrade Digital Services (CDS) should strengthen DAVA’s position in South West Europe. A calendar year has passed since the purchase and the revenue share was 6.1% (27.2% in the Other segment).

The acquisitions of Levvel and Five were finalized at the end of the third quarter of 2021, and these companies will strengthen Endava’s presence in the North American market. Their share in the annual income was about 4%; they are included in the “Financial Services and Payments” and “TMT” segments. Thus, the share of acquired companies in turnover is 10%.

According to management’s expectations for 2022, total revenues will increase by 40-41%, to approximately $849.4 million, and the share of Five, Levvel and CDS will exceed 20%. Endava has spent over $130 million on acquisitions. Thus, companies acquired in 2023 will bring in revenues equivalent to the amount spent on their acquisitions; i.e. DAVA paid multiple EV/Sales [FWD] – 1x, which is cheap enough for growing businesses.

Judging by the dynamics and growing share of the region, Endava has focused on North America. Since 2017, the region’s share has almost doubled and the growth rate exceeds the growth rate of total revenue. Revenue and share dynamics for the NA region are shown below.

in millions $ 2017 2018 2019 2020 2021
Total income 207.6 287.2 365.6 434.9 617.3
North American revenue 33.8 60.31 100.54 123.94 193.83
Total revenue growth

38.3%

27.3% 18.9% 41.9%
NA Growth 78.4% 66.7% 23.3% 56.3%
To share 16.3% 21.1%

27.5%

28.5% 31.4%

(Source: Created by author, based on company data)

North America is the largest computer and software market in the world and is estimated at $311.1 billion; according to Statistical, it will grow with a CAGR of 7% and reach 437.95 billion by 2026. Endava can grow more than twice the current North American market revenue by 2026 if it reaches the same market share as in Europe (0.01%). Given current growth rates and acquisitions, it is quite likely.

Potential of the banking sector

It should be noted that Levvel is one of the leaders in banking advice in the USA. One of the 50 largest banks in the United States, along with Levvel and other companies (Finxact, Savana and Apiture), has begun to develop the concept of a fully autonomous digital bank. According to Levvel, it will take 106 days. Through Levvel’s partnership with Finxact and the creation of the concept of digital banking, Endava can significantly expand the client portfolio of the US banking industry.

Potential customers are medium and small banks with assets not exceeding $10 billion. According to the Fed, the total value of small commercial bank assets is about $6 trillion. Small and medium banks dedicate 1-3% of their assets to digital transformation, so Endava’s potential market is estimated at $60-70 billion.

Size of bank assets > $10 billion $1B – $10B $500M – $1B Medium
Average technique. budget $21M $3 million $1 million $275,000 $1.7M
% actives 0.8% 1.0% 1.0% 3.0% 1.45%

(Source: directordebanque.com)

Temporary headwinds and long-term potential

Over the past five years, the average annual revenue growth rate has been 32%. According to management’s expectations, revenues will increase by 40-41% in 2022 and will reach £615-620 million (approximately $849.4 million).

Income

Created by author

Since 2019, the number of customers has increased by 124% (+340), while CDS, Five and Level have attracted 136 (40%). Thus, Endava increases the customer base through acquisitions and organically.

Total number of customers

Created by author

Although the number of employees is increasing by an average of 30% per year and should continue to grow at a comparable rate, Endava is steadily increasing its turnover per employee. For five years, revenue per total employee grew from $55.5K to $69.8K in the first quarter of 2022. Management also reported an increase in utilization to 71%. Revenue per employee increases because the company’s products are relatively versatile and do not require extensive customization for each customer. For this reason, we expect the company’s margins to increase over the long term.

Revenue per employee

Created by author

Although we expect the gross margin to increase in the long term, in the short term the indicator could come under pressure due to accelerating inflation, as salaries represent more than 90% of all expenses. by DAVA. On average, over the past ten years, wages in the region have increased at a rate comparable to inflation in the European Union.

Endava PLC gross profit margin
Data by Y-Charts

Thus, Endava is a growing company that is successfully growing its customer base both organically and through acquisition. Although the business may become more profitable in the long term, as revenue per employee and usage increase steadily, we expect gross margin to be under pressure in the short term due to the acceleration of the ‘inflation.

Evaluation

In our DCF model, we made several assumptions. We expect revenues to grow in line with the Wall Street consensus, with growth slowing later. Relative indicators, including profitability, are predicted based on historical dynamics and current trend. The terminal’s growth rate is 5%. Our assumptions are presented below:

Hypotheses

Created by author

Based on our assumptions, the expected dynamics of the key indicators are presented below:

Main ratios

Created by author

With a cost of equity equal to 8.33%, the Weighted Average Cost of Capital [WACC] is 8.3%.

WACC

Created by author

With Terminal EV/EBITDA equal to 31.86x, our model predicts a fair market value of $8.5 billion, or $154 per share. The company is trading at a 16% discount to our estimate of fair value.

Endava doesn’t look cheap by the multipliers. However, it trades cheaper than its nearest competitor, GLOB.

DAVA WORLD EPAM INFI PRFT
P/E 91.9x 121.3x 60.9x 33.1x 62.7x
EV / EBITDA 56.2x 55.5x 43.6x 22.7x 28.1x

Conclusion

Endava is actively expanding into the largest and most competitive North American market. DAVA can more than double its current regional revenue if it achieves the same market share as in Europe. Through Level and five acquisitions, DAVA has strengthened its presence in the US banking industry, providing immense room for growth. Final acquisitions have no problem with customer growth. It grows both organically and at the expense of “gross profit” “End profit”. We are bullish on the business.

About Eleanor Blackburn

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